Chapter 1 Foreign Exchange Management

Introduction

The Foreign Exchange Management Act, 1999 (FEMA), is an Act of the Parliament of
India "to consolidate and amend the law relating to foreign exchange with the objective of
facilitating external trade and payments and for promoting the orderly development and
maintenance of foreign exchange market in India".It was passed on 29 December 1999 in
parliament, replacing the Foreign Exchange Regulation Act (FERA). This act makes offences
related to foreign exchange civil offenses. It extends to the whole of India, replacing FERA,
which had become incompatible with the pro-liberalization policies of the Government of India.
It enabled a new foreign exchange management regime consistent with the emerging framework
of the World Trade Organization (WTO).

Current Account Transaction [Section 2(j)]

The term current account transaction has been defined to mean a transaction other than a capital
account transaction and includes payments due in connection with foreign trade, other current
business, services and short term banking and credit facilities in the ordinary course of business;
payments due as interest on loan and as net income from investments; remittances for living
expenses of parents, spouse and children residing abroad and expenses in connection with
foreign travel, education and medical care of parents, spouse and children.

Under the Act freedom has been granted for selling and drawing of foreign exchange to or from
an authorized person for undertaking current account transactions. However, the Central
Government has been vested with powers in consultation with Reserve Bank to impose
reasonable restrictions on current account transactions.

Foreign Exchange Management (Current Account Transactions) Rules, 2000 defines the
term ‘Drawal

as to mean drawal of foreign exchange from an authorised person and includes opening of Letter
of Credit or use of International Credit Card or International Debit Card or ATM Card or any
other thing by whatever name called which has the effect of creating foreign exchange liability.

Foreign Exchange [Section 2(n)]

The term ‘foreign exchange has been defined to mean foreign currency and includes deposits,
credits, balance payable in foreign currency, drafts, travellers cheques, letters of credit, bills of
exchange expressed or drawn in Indian currency but payable in any foreign currency. Any draft,
travellers cheque, letters of credit or bills of exchange drawn by banks, institutions or persons
outside India but payable in Indian currency has also been included in the definition of foreign
exchange.
Prohibition on drawal of foreign exchange for certain transactions

Rule 3 prohibits the drawal of foreign exchange for the purposes of transactions specified in the
Schedule I or a travel to Nepal and/or Bhutan or a transaction with a person resident in Nepal or
Bhutan. However, in the case of transaction with a person resident in Nepal and Bhutan, the
prohibition may be exempted by RBI subject to such terms and conditions as it may consider
necessary. Schedule I to the Rules enumerate the situations in which the drawal of foreign
exchange is prohibited. These are as follows:

(a) Remittance out of lottery winnings;

(b) Remittance of income from racing/riding etc. or any other hobby;
(c) Remittance for purchase of lottery tickets, banned/prescribed magazine, football pools, sweep
stakes etc.
(d) Payment of commission on exports made towards equity investment in joint ventures/wholly
owned subsidiaries abroad of Indian Companies.

Capital account transaction

Section 6 allows capital account transactions subject however to certain conditions. This section
empowers the Reserve Bank of India to specify, in consultation with the Central Government,
any class or classes of capital account transactions permissible and the limit upto which foreign
exchange shall be admissible for such transactions. However, Reserve Bank shall not impose any
restrictions on the drawal of foreign exchange for payments due on account of amortization
(writing off) of loans or for depreciation of direct investments in the ordinary course of business.

The Reserve Bank of India may, by regulations, prohibit, restrict or regulate the transfer or issue
of any foreign security by a person resident in India or by a person resident outside India.
Reserve Bank of India may also regulate, prohibit or restrict transfer or issue of any security or
foreign security through any branch office, or agency in India of a person resident outside India.
Any borrowing or lending in foreign exchange in whatever form or by whatever name called
may also be regulated or prohibited by the Reserve Bank. Similarly, RBI may also prohibit or
restrict any borrowing or lending in rupees in whatever form or by whatever name called
between a person resident in India and a person resident outside India. Deposits between persons
resident in India and persons resident outside India may be regulated or prohibited by the
Reserve Bank of India. RBI may also regulate the export, import or holding of currency or
currency notes.

Acquisition or transfer of immovable property other than on lease not exceeding five years in
India by person resident in India or a person resident outside India may be prohibited or
regulated by the Reserve Bank of India.

Sub-section (4) allows a person resident in India to hold, own, transfer or invest in foreign
currency, foreign security or any immovable property situated outside India, if such currency,
security or property was acquired, held or owned by such person when he was resident outside
India or inherited from a person who was resident outside India. Similarly, a person resident
outside India is permitted to hold, own, transfer or invest in Indian currency, security, or any
immovable property situated in India if such currency, security or property was acquired, held or
owned by such person when he was resident in India or inherited from a person who was resident
in India.

Foreign Security [Section 2(o)]

The term Foreign Security has been defined to mean any security, in the form of shares, stocks,
bonds, debentures or any other instrument denominated or expressed in foreign currency and
includes securities expressed in foreign currency but where redemption or any form of return
such as interest or dividend is payable in Indian currency.

Classes of Capital Account Transactions of Persons Resident in India

(i) investment by a person resident in India in foreign securities. (P)

(ii) foreign currency loans raised in abroad by a person resident in India; (R)

(iii) transfer of immovable property outside India by a person resident in India; (R)

(iv) guarantees issued by a person resident in India in favour of a person resident outside India;
(P)

(v) export, import and holding of currency/currency notes;

(vi) loans and overdrafts by a person resident in India from a person resident outside India; (R)

(vii) maintenance of foreign currency accounts in India and outside India by a person resident in
India; (P)

(viii) taking out of insurance policy by a person resident in India from an insurance company
outside India; (P)

(ix) loans and overdrafts by a person resident in India to a person resident outside India; (P)

(x) remittance outside India of capital assets of a person resident in India; (P)

(xi) sale and purchase of foreign exchange derivatives in India and abroad and commodity
derivatives abroad by a person resident in India. (R)
Classes of Capital Account Transactions of Persons Resident Outside India

(i) Investment in India by a person resident outside India, that is to say:

(a) issue of security by a body corporate or an entity in India and investment therein by a person
resident outside India; and
(b) investment by way of contribution by a person resident outside India to the capital of a firm
or a proprietorship concern or an association of persons in India.

(ii) Acquisition and transfer of immovable property in India by a person resident outside India.
(P)

(iii) Guarantee by a person resident outside India in favour of, or on behalf of a person resident
in India. (R)

(iv) Import and export of currency/currency notes into/from India by a person resident outside
India.

(v) Deposits between a person resident in India and a person resident outside India.

(vi) Foreign Currency accounts in India of a person resident outside India. (R)

(vii) Remittance outside India of capital assets in India of a person resident outside India. (P)

Remittance and repatriation

Remittance of sale proceeds/Remittance on winding up/Liquidation of Companies: ─

Sale proceeds of shares and securities and their remittance is ‘remittance of asset’ governed by
The Foreign Exchange Management (Remittance of Assets) Regulations under FEMA.

AD Category-I bank can allow the remittance of sale proceeds of a security (net of applicable
taxes) to the seller of shares resident outside India, provided the security has been held on
repatriation basis, the sale of security has been made in accordance with the prescribed
guidelines and NOC/tax clearance certificate from the Income Tax Department has been
produced.

Penalties

Person
If a person violates/contravenes any FDI Regulations, by way of breach/non-
adherence/noncompliance/contravention of any rule, regulation, notification, press note, press
release, circular, direction or order issued in exercise of the powers under FEMA or contravenes
any conditions subject to which an authorization is issued by the Government of
India/FIPB/Reserve Bank of India, he shall, upon adjudication, be liable to a penalty up to thrice
the sum involved in such contraventions where such amount is quantifiable, or up to two lakh
Rupees where the amount is not quantifiable,

And where such contraventions is a continuing one, further penalty which may extend to five
thousand Rupees for every day after the first day during which the contraventions continues.

Company
Where a person committing a contravention of any provisions of this Act or of any rule, direction
or order made there under is a company (company means any body corporate and includes a firm
or other association of individuals as defined in the Companies Act), every person who, at the
time the contravention was committed, was in charge of, and was responsible to, the company
for the conduct of the business of the company as well as the company, shall be deemed to be
guilty of the contravention and shall be liable to be proceeded against and punished accordingly.

Any Adjudicating Authority adjudging any contraventions under 3.1(i) above, may, if he thinks
fit in addition to any penalty which he may impose for such contravention direct that any
currency, security or any other money or property in respect of which the contravention has
taken place shall be confiscated to the Central Government.