Foreign Exchange Management Act (FEMA) Regulations for Cross-Border Transactions

Table of Contents

Introduction

The Foreign Exchange Management Act (FEMA) enacted by the Parliament of India in 1999 was to consolidate and amend the laws relating to foreign exchange. It replaced the earlier Foreign Exchange Regulation Act (FERA), 1973, which was deemed more restrictive and not in line with India’s post-liberalization policies.

FEMA serves as a comprehensive regulatory framework governing various aspects of foreign exchange transactions, external trade, and payments in India. The primary objective of FEMA is to facilitate external trade and payments while promoting the orderly development and maintenance of the foreign exchange market in the country.

The Act empowers the Reserve Bank of India (RBI) to regulate and manage foreign exchange transactions, and enables the Central Government to pass rules relating to foreign exchange in consultation with the RBI.

Objectives of FEMA

The key objectives of the FEMA are:

To facilitate external trade and payments
To promote the orderly development and maintenance of the foreign exchange market in India
To conserve and properly utilize the foreign exchange resources of the country
To regulate and manage foreign exchange transactions
To prevent illegal activities such as money laundering, financing of terrorism, and unauthorized foreign exchange transactions
To ensure compliance with international obligations and best practices

FEMA aims to strike a balance between facilitating legitimate foreign exchange transactions and preventing misuse or illegal activities that could harm the country’s economic interests.

Applicability and Jurisdiction of FEMA

FEMA extends to the whole of India and applies to all branches, offices, and agencies outside India that are owned or controlled by a person resident in India. The Act also applies to any contravention committed outside India by any person to whom the Act applies.

FEMA categorizes foreign exchange transactions into two main categories:

Current Account Transactions: These include transactions related to trade in goods and services, remittances, and payments.
Capital Account Transactions: These include transactions involving investments, acquisition of property, securities, etc.

The Act provides a framework for regulating and managing these transactions, with the RBI being the primary administrative body responsible for its implementation.

Key FEMA Regulations for Cross-Border Transactions

Transaction Regulations under FEMA

Current Account Transactions

Current Account Transactions refer to transactions that involve inflow and outflow of foreign currency for purposes such as trade, services, income, and short-term banking and credit facilities in the ordinary course of business. These transactions are defined under Section 2(j) of FEMA.

Prohibited Transactions

Rule 3 of the Foreign Exchange Management (Current Account Transactions) Rules, 2000 prohibits the withdrawal of foreign exchange for certain transactions, such as:

Remittance out of lottery winnings
Remittance of income from racing/riding or any other hobby
Remittance for purchase of lottery tickets, banned or proscribed magazines, football pools, sweepstakes, etc.
Payment of commission on exports made towards equity investment in Joint Ventures/Wholly Owned Subsidiaries abroad of Indian companies

These prohibitions are aimed at preventing the misuse of foreign exchange for speculative or illegal activities.

Transactions Requiring RBI Permission

Certain Current Account Transactions require prior approval from the RBI as per Rule 5 and Schedule III of the Foreign Exchange Management (Current Account Transactions) Rules, 2000. These include:

Remittance exceeding USD 1,000,000 per project for any consultancy services procured from outside India
Remittance exceeding USD 100,000 by an entity or individual for donation
Remittance exceeding USD 10,000,000 by a corporate for donation

The RBI permission ensures proper oversight and monitoring of significant foreign exchange outflows.

Transactions Requiring Central Government Approval

Some Current Account Transactions require prior approval from the Central Government as per Rule 4 and Schedule II of the Foreign Exchange Management (Current Account Transactions) Rules, 2000. These include:

Cultural tours conducted by the Ministry of Human Resources Development (Department of Education and Culture)
Advertisement in foreign print media for purposes other than promotion of tourism, foreign investments, and international bidding by a State Government and its Public Sector Undertakings (exceeding USD 10,000)
Remittance of freight of vessel chartered by a Public Sector Undertaking
Payment of import by a Public Sector Undertaking or a Government Department through an ocean transport by a foreign shipping company

Capital Account Transactions under FEMA

Capital account transactions involve the transfer of capital assets and liabilities between residents and non-residents. These transactions are regulated by the RBI under FEMA, 1999. The key regulations for capital account transactions are as follows:

Foreign Direct Investment (FDI) Regulations

FDI refers to investment by non-resident entities in the capital of an Indian company. The FDI policy is formulated by the Department for Promotion of Industry and Internal Trade (DPIIT) and is notified through the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

FDI can be made through the automatic route (without prior approval) or the government route (with prior approval) depending on the sector.
Sectoral caps and entry routes are specified in the FDI policy. For example, 100% FDI is allowed in the manufacturing sector under the automatic route, while FDI in the insurance sector is capped at 49% under the automatic route.
FDI in certain sectors such as lottery business, gambling, and chit funds is prohibited.
Reporting requirements include filing of Form FC-GPR for issue of capital instruments and Form FC-TRS for transfer of capital instruments.

Overseas Direct Investment (ODI) by Indian Entities

ODI refers to investment by Indian entities in joint ventures (JVs) and wholly owned subsidiaries (WOS) outside India. ODI is governed by the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.

ODI can be made under the automatic route up to the prescribed limits. For example, the total financial commitment (TFC) limit is 400% of the net worth of the Indian entity.
ODI exceeding the limits requires prior approval of the RBI.
Indian entities can invest in JVs/WOS engaged in bona fide business activities, except certain sectors such as real estate and banking.
Reporting requirements include filing of Form ODI for remittance and share allotment, and Annual Performance Report (APR) for performance of the JV/WOS.

External Commercial Borrowings (ECB)

ECB refers to commercial loans availed by eligible Indian entities from recognized non-resident lenders. ECB is governed by the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018.

ECB can be availed under the automatic route or the approval route depending on the amount, maturity, and end-use.
The all-in-cost ceiling for ECB is linked to the benchmark rate plus a spread. For example, the benchmark rate for ECB with minimum average maturity of 3-5 years is 6-month LIBOR or applicable benchmark.
ECB proceeds can be used for capital expenditure, working capital, and general corporate purposes, except certain end-uses such as real estate activities and purchase of land.
Reporting requirements include obtaining a Loan Registration Number (LRN) and filing of Form ECB for each ECB transaction.

These regulations aim to monitor and manage capital flows in line with macroeconomic stability and national interests. It is important for entities undertaking capital account transactions to comply with the applicable regulations and reporting requirements to avoid any contraventions under FEMA.

Cross-Border Mergers and Investments

The Foreign Exchange Management (Cross Border Merger) Regulations, 2018, establish a legal framework for mergers and arrangements between Indian and foreign companies, emphasizing legal certainty and economic stability. Similarly, the Foreign Exchange Management (Debt Instruments) Regulations, 2019 regulate investments by non-residents in debt instruments, ensuring financial stability and defining permissible investments.

Deposits and Security Regulations

The Foreign Exchange Management (Deposit) Regulations, 2016, provide guidelines for non-resident deposits, enhancing economic engagement and protecting against financial misuses. Additionally, the amendments to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulation, 2019 bolster the regulatory framework for e-commerce and promote fair trade practices.

Acquisition and Transfer of Immovable Property under FEMA

Regulations for Non-Resident Indians (NRIs)

NRIs are allowed to acquire immovable property in India, subject to certain conditions and restrictions under the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018.

NRIs can acquire any immovable property in India other than agricultural land, plantation property, or a farmhouse. The purchase can be made using funds received in India through normal banking channels by way of inward remittance from any place outside India or by debit to their NRE/FCNR(B)/NRO account.

NRIs are also allowed to transfer any immovable property in India to a person resident in India. They can transfer residential or commercial property in India to another NRI or a Person of Indian Origin (PIO). However, the transfer of agricultural land, plantation property, or farmhouse by NRIs is not permitted.

The payment for the transfer of immovable property by an NRI should be made through banking channels in accordance with the prescribed methods. Repatriation of sale proceeds is allowed for up to two residential properties, subject to conditions.

Regulations for Foreign Nationals

Foreign nationals of non-Indian origin, resident outside India, are not permitted to acquire any immovable property in India unless such acquisition is by way of inheritance from a person who was resident in India. However, they can acquire or transfer immovable property in India, on lease, not exceeding five years.

Foreign Nationals of non-Indian origin who have acquired immovable property in India with the specific approval of the RBI can transfer such property with the prior permission of the RBI.

Role of RBI in Administering FEMA

Powers and Functions of RBI under FEMA

Under FEMA, RBI has been granted extensive powers to manage and regulate foreign exchange transactions. Some of the key powers and functions of RBI include:

Granting Approvals: RBI has the authority to grant approvals for certain foreign exchange transactions, such as FDI, external commercial borrowings (ECB), and ODI [Section 6(3) of FEMA].
Specifying Conditions: RBI can specify conditions for capital account transactions involving debt instruments [Section 6(2) of FEMA]. It can also impose reasonable restrictions on current account transactions in consultation with the Central Government [Section 5 of FEMA].
Issuing Directions: RBI can issue directions to authorized persons (banks and money changers) regarding foreign exchange dealings [Section 11 of FEMA]. These directions, known as AP (DIR) circulars, ensure compliance with FEMA provisions.
Regulating Export Proceeds: RBI can specify the period and manner in which foreign exchange due from exports should be received [Section 8 of FEMA].
Granting Exemptions: RBI has the power to grant exemptions from the realization and repatriation of foreign exchange in certain cases [Section 9 of FEMA].

Foreign Exchange Department of RBI

The Foreign Exchange Department (FED) of RBI is responsible for the day-to-day administration of FEMA. The FED is headquartered in Mumbai and has regional offices across India. Its main functions include:

Formulating policies and regulations related to foreign exchange transactions.
Granting approvals and permissions for various foreign exchange transactions.
Monitoring and supervising the foreign exchange market to ensure compliance with FEMA provisions.
Conducting inspections and investigations of authorized persons (banks and money changers) to verify adherence to FEMA guidelines.
Providing guidance and clarifications to stakeholders on FEMA-related matters.

Master Directions and Circulars Issued by RBI

To provide clarity and guidance on various aspects of FEMA, RBI issues Master Directions and circulars from time to time. These documents consolidate and update the instructions, guidelines, and regulations related to specific areas of foreign exchange transactions. Some of the key Master Directions issued by RBI include:

Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations.
Master Direction on Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad.
Master Direction on Establishment of Branch Office (BO) / Liaison Office (LO) / Project Office (PO) or any other place of business in India by foreign entities.
Master Direction on Remittance of Assets.

These Master Directions provide comprehensive guidelines and instructions on the respective topics, ensuring clarity and uniformity in the application of FEMA provisions. In addition to Master Directions, RBI also issues circulars to communicate changes, updates, or clarifications related to FEMA regulations. These circulars are issued through the AP (DIR) series and are binding on all authorized persons and entities involved in foreign exchange transactions.

Penalties and Contraventions under FEMA

Types of Contraventions under FEMA

Contraventions under FEMA refer to any violation or breach of the provisions outlined in the Act, rules, regulations, notifications, directions, or orders issued by the RBI. Some common types of contraventions include:

Non-compliance with reporting requirements, such as failure to submit required reports, returns, or information to the RBI within the stipulated timelines.
Unauthorized transactions, such as engaging in foreign exchange transactions without proper authorization or conducting prohibited or restricted transactions.
Non-repatriation of export proceeds within the specified timeframe or non-compliance with repatriation requirements.
Violation of FDI guidelines, including exceeding sectoral caps, incorrect reporting of investments, or contravening conditions imposed by the RBI.

Penalties for FEMA Violations

Monetary Penalties

Under Section 13 of FEMA, if any person contravenes any provision of the Act, rule, regulation, notification, direction, or order issued by the RBI, they shall be liable to a penalty:

Up to thrice the sum involved in the contravention where such amount is quantifiable, or
Up to Rs. 2 lakh where the amount is not quantifiable, and if the contravention is a continuing one, a further penalty of up to Rs. 5,000 per day during which the contravention continues.

Additionally, under Section 13(1A), if a person is found to have acquired foreign exchange, foreign security, or immovable property situated outside India of an aggregate value exceeding the prescribed threshold (currently Rs. 1 crore), they shall be liable to a penalty up to three times the sum involved and confiscation of the equivalent value.

Compounding of Offences

Section 15 of FEMA empowers the RBI to compound contraventions under the Act, except for contraventions under Section 3(a) dealing with Hawala transactions, which are handled by the Enforcement Directorate. Compounding refers to the process of voluntarily admitting the contravention and paying a specified sum to settle the matter without undergoing formal legal proceedings.

The compounding authority can be an Assistant General Manager, Deputy General Manager, General Manager, or Chief General Manager of the RBI, depending on the sum involved in the contravention. The application for compounding must be submitted along with the prescribed fee of Rs. 5,000, and the contravention must be quantifiable.

Adjudication Proceedings

For serious or repeated contraventions, the RBI may initiate adjudication proceedings under Section 16 of FEMA. The Adjudicating Authority, appointed by the Central Government, conducts the proceedings and has the power to impose penalties based on the findings.

The Adjudicating Authority issues a show-cause notice to the person alleged to have committed the contravention, providing them an opportunity to present their case. If satisfied that a contravention has occurred, the Adjudicating Authority may impose a penalty as per Section 13 of FEMA.

Consequences of Non-Compliance

Legal Implications

Non-compliance with FEMA can lead to various legal consequences:

Penalties: As mentioned earlier, monetary penalties can be imposed for contraventions under Section 13 of FEMA.
Prosecution: In certain cases, such as wilful and malafide transactions, the Adjudicating Authority may recommend prosecution under Section 13(1B) of FEMA. The Director of Enforcement may then file a criminal complaint against the person.
Confiscation: Under Section 13(2) of FEMA, in addition to any penalty, the Adjudicating Authority may direct the confiscation of any currency, security, or money in respect of which the contravention has taken place.
Arrest and Civil Imprisonment: If a person fails to pay the penalty imposed within 90 days, they may be liable for civil imprisonment under Section 14 of FEMA. The Adjudicating Authority may issue an arrest warrant if satisfied that the defaulter is likely to abscond or not appear before the authority.

Non-compliance with FEMA can also result in reputational damage, difficulties in future cross-border transactions, and loss of investor confidence. It is crucial for individuals and entities to ensure compliance with FEMA provisions to avoid legal and financial consequences.

Recent Developments and Amendments in FEMA Regulations

Liberalised Remittance Scheme (LRS)

The LRS permits resident individuals to freely remit up to USD 250,000 per financial year for any permissible current or capital account transaction or a combination of both. Initially introduced on February 4, 2004, with a limit of USD 25,000, it has seen gradual increases over time.

Key points about LRS:

LRS encompasses various transactions including overseas education, travel, medical treatment, property purchase, investments abroad, and establishment of wholly owned subsidiaries and joint ventures outside India.
Remittances under LRS can be aggregated for close relatives, allowing higher amounts to be remitted per transaction.
From July 1, 2022, resident individuals are allowed to make international payments using Prepaid Payment Instruments (PPIs) issued by Indian banks and authorized non-bank PPI issuers.

Changes in Overseas Investment Norms

The overseas investment framework has been significantly revised with the introduction of the Foreign Exchange Management (Overseas Investment) Rules, 2022 and the Foreign Exchange Management (Overseas Investment) Regulations, 2022, effective from August 22, 2022.

Key highlights of the new overseas investment norms:

Earlier regulations on overseas investments have been consolidated into a single regulation, covering various aspects such as overseas direct investment, investment in immovable properties, and other financial assets.
Introduction of the “strategic sector” concept permits Indian entities to make overseas investments exceeding prescribed limits in foreign entities engaged in strategic sectors, subject to prior approval from the RBI.
Indian entities are now allowed to make overseas direct investments in foreign entities engaged in financial services activities, except banking and insurance, subject to prescribed conditions.
A Late Submission Fee (LSF) has been introduced for delays in reporting requirements, payable according to rates specified by the RBI.

Introduction of New Reporting Systems

To enhance the reporting and monitoring of foreign exchange transactions, the RBI has introduced new reporting systems and made amendments to existing ones.

Key developments in reporting systems:

The introduction of FIRMS (Foreign Investment Reporting and Management System), a web-based reporting portal, for reporting foreign investment in India.
Streamlining of reporting requirements for overseas investments under the new regulations, with the introduction of a single Master Form for reporting various overseas investment transactions.
Introduction of the LSF framework for delayed reporting, providing an opportunity for regularizing delayed reporting by paying the specified LSF.

These recent developments and amendments in FEMA regulations aim to simplify and streamline processes related to foreign exchange transactions, provide clarity on the regulatory framework, and facilitate ease of doing business. It is crucial for individuals and entities engaged in cross-border transactions to stay updated with these changes and ensure compliance with the revised regulations.

Conclusion

FEMA plays a crucial role in regulating cross-border transactions and ensuring compliance with India’s foreign exchange laws. The introduction of FEMA in 1999 marked a significant shift from the earlier restrictive FERA regime, facilitating external trade and payments while promoting the orderly development of the foreign exchange market. FEMA provides a comprehensive framework for managing various aspects of cross-border transactions, including current account transactions, capital account transactions, foreign direct investment, overseas direct investment, and borrowing and lending in foreign exchange.

Compliance with FEMA regulations is essential for businesses and individuals engaging in cross-border transactions to avoid penalties and legal consequences. The RBI acts as the central authority in administering FEMA, issuing guidelines, granting approvals, and monitoring compliance.

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