OVERVIEW OF FOREIGN EXCHANGE MANAGEMENT ACT
BACKGROUND – EVOLUTION OF FOREIGN EXCHANGE REGULATIONS IN INDIA
Exchange regulations have always remained at the centre of Indian economy. Exchange controls
were first introduced in India during the Second World War (1942). Soon after independence, they
were formally reaffirmed in form of the first Foreign Exchange Regulation Act, 1949 (FERA). This was
followed by FERA, 1973. The control framework under FERA was essentially transaction based in
terms of which all transactions in foreign exchange including those between residents to nonresidents
were prohibited unless specifically permitted.
Transformation from control-to-management: FERA to FEMA
The 1970s and 1980s saw the rise of large external sector imbalances on account of persistent
increase in adverse balance of payments situation. There was over dependence on official foreign
aid. It was this balance of payment crisis that triggered the wave of economic liberalization. The
Indian rupee became market determined in 1993. The need was felt to consolidate and amend the
law relating to foreign exchange with the objectives of facilitating external trade and payments and
for promoting the orderly development and maintenance of foreign exchange market in India.
Accordingly, on June 1, 2000, the Foreign Exchange Management Act, 1999 (FEMA) was brought in
force to replace the then existing Foreign Exchange Regulation Act, 1973 (FERA). FEMA has been
enacted with an objective of facilitating external trade and payments and for promoting the orderly
development and maintenance of foreign exchange market tin India. As such it is quite opposed to
FERA which was enacted to regulate or control the foreign exchange. FEMA provided a de jure status
to the shift in policies with regard to the external sector reforms that began in 1990-91.
STRUCTURE OF FEMA
The present framework of exchange controls in India, consist of basic legislation (FEMA, 1999) and
Notifications, Rules and Circulars [known as Authorized Persons Directions – AP (Dir Series)] issued
by RBI. FEMA applies to the whole of India and all branches, offices and agencies outside India which
are owned or controlled by a person resident in India. It also applies to any contraventions
committed outside India by any person to whom FEMA applies.
There are 49 sections under FEMA, of which 9 sections (section 1 to 9) are substantive and the rest
are procedural / administrative provisions as tabulated below:
Section Description
1 Application and Commencement of FEMA
2 Definitions
3 to 9 Provisions relating to Regulations and Management of Foreign Exchange
10 to 12 Provisions relating to Authorized Person
13 to 15 Provisions relating to Contraventions and Penalties
16 to 38 Provisions relating to Adjudication, Appeal and Directorate of Enforcement
39 to 49 Miscellaneous Provisions
Section 46 of FEMA grants power to the Central Government to make rules to carry out the
provisions of FEMA and Section 47 of FEMA grants power to the Reserve Bank of India (RBI) to make
regulations to implement provisions and the rules made under FEMA. Thus RBI is entrusted with the
administration and implementation of FEMA.
CAPITAL ACCOUNT TRANSACTION AND CURRENT ACCOUNT TRANSACTION:
In August 1994 India accepted Article VIII of the Articles of agreement of the International Monetary
Fund and became fully convertible on the current account. Since India is fully convertible on the
current account, all current account transactions (barring a small list of restricted items) are allowed
through the normal banking channels. In case of capital account transactions, only the transactions
which are explicitly enabled under the guidelines are allowed, remaining require specific approvals
under FEMA.
Accordingly it is very important to understand the concept of Capital and Current Account
Transactions to Comprehend FEMA.
A. Capital Account Transaction:
“Capital Account transaction” is defined under section 2(e) of FEMA as ‘a transaction which
alters the assets or liabilities, including contingent liabilities, outside India of persons resident in
India or assets or liabilities in India of persons resident outside India, and includes transactions
referred to in sub-section (3) of section 6.’
Thus any transaction as a result of which the assets or liabilities outside India of a person who is
resident in India and assets or liabilities in India of a person who is resident outside India are
altered i.e. either increased or decreased, is a capital account transaction.
To put it in example, if a person resident in India acquires shares of a foreign company, his/her
overseas assets will increase. Similarly, if the same person borrows from a non resident through
External Commercial Borrowings (ECBs) his/her liability is created outside India. Hence, both the
transactions lead to creation of asset or liability outside India of a person resident in India. Both
the transactions are capital account transactions.
In case of a person resident outside India, if he acquires shares of an Indian company, his/her
asset is created in India and if same person borrows from an institution in India for acquiring
house in India, his/her liability will be created in India. Both these transactions lead to creation
of asset or liability in India of a person resident outside India. Hence, both the transactions are
capital account transactions.
The concept of Capital and Current Account transaction is to be seen from Balance of Payment
point of view. If after the completion of transaction there remains any obligation to either pay
or receive foreign exchange, the transaction would get colour of Capital Account transaction.
For example, import of Plant & Machinery is a current account transaction, as upon import the
machinery is received in India and overseas supplier is say paid within six months from import
and accordingly there is no future obligation on India as a country to honour foreign exchange
obligation. In this example, from accounting perspective, though Plant & Machinery would be
capital goods, but for FEMA it would be a current account transaction.
RBI has been empowered under section 6(2) of FEMA to specify, in consultation with the Central
Government, any class or classes of Capital Account transactions which are permissible [i.e. over
and above the transactions permitted under section 6(3)]. Section 6(3) of FEMA specifies the
classes of capital account transactions which are regulated by RBI. Every transaction listed in this
section is regulated by a corresponding notification/regulation.
FEMA Notification No. 1/2000-RB dated 3-5-2000 contains the list of permissible capital account
transactions as well as list of prohibited capital account transactions.
Prohibited Capital Account Transactions:
General Prohibition:
A person shall not undertake or sell or draw foreign exchange to or from an Authorized person
for any capital account transactions other than those permitted in the Schedules, provided the
transaction is within the limit.
Special Prohibition:
No person resident outside India shall make investment in India, in any form, in any company or
partnership firm or proprietary concern or any entity, whether incorporated or not, which is
engaged or proposes to engage-
In the business of chit fund, or
As nidhi company, or
In agricultural or plantation activities, or
In real estate business, or construction of farm houses, or
In trading in Transferable Development Rights (TDRs)
(real estate shall not include development of townships, construction of residential/commercial
premises, roads or bridges).
B. Current Account Transaction:
“Current account transaction” is defined under section 2(j) of FEMA to mean ‘a transaction
other than a capital account transaction and without prejudice to the generality of the foregoing
such transaction includes,-
(i) payments due in connection with foreign trade, other current business, services and shortterm
banking and credit facilities in the ordinary course of business,
(ii) payments due as interest on loans and as net income from investments,
(iii) remittances for living expenses of parent, spouse and children residing abroad, and
(iv) expenses in connection with foreign travel, education and medical care of parents, spouse
and children.’
All Current Account transactions are generally permitted unless specifically prohibited whereas
all Capital Account transactions are generally prohibited unless specifically permitted.
Current Account transactions are divided into 3 schedules in Current Account Transaction rules:
Schedule I – Prohibited Transactions
Schedule II – Transactions requiring prior approval of Government of India
Schedule III – Transactions requiring prior approval of RBI
EXAMPLES TO UNDERSTAND CAPITAL AND CURRENT ACCOUNT TRANSACTIONS:
a. Import of Machinery on hire purchase:
In this transaction the person has created future obligation for making payment to nonresident
and hence has liability towards the non-resident. Therefore the said transaction is a
capital account transaction.
b. Transaction representing creation or acquisition of wealth, shares, loans or immovable
properties:
Since such types of transactions would lead to creation of assets in or outside India by
person resident outside or in India, as the case may be, the same are in nature of capital
account transactions.
c. Remittances out of winnings from lottery:
This comes under Prohibited list (Schedule I) of the Current account transaction. Hence
although the same is in nature of current account such transactions are prohibited.
However, an entity engaged in lottery business, imports any software or machinery to be
utilized in lottery business in India, the same is a permissible transaction. Import of software
or machinery will not result in violation of FEMA regulations in relation to current account
transactions.
But any type of technical collaboration for lottery business including licensing for franchise,
trademark, brand name, management contract or any contract for payment of royalty as
such for such collaboration is prohibited under both current account transaction rules and
also under FDI Policy. Hence, such transactions are not permissible.
d. Options premium payable under NASDAQ:
Options premium is the price paid by a person to buy an option contract, whether it is a call
or put. So option premium is paid to acquire only specified rights for a contract. Under
option contract there is no future obligation in addition to option premium paid at the time
of entering into contract so it does not result into creation of any contingent liability and
hence is a current account transaction. Whereas future contract would be a capital account
transaction. Option contract may result into creation of contingent asset, and such
contingent asset is not covered in the definition of Capital Account transaction.
e. Opening a branch outside India:
Opening a branch outside India is a current account transaction as it does not result into
alteration of any assets and liabilities overseas, since overseas branch would be regarded as
Resident of India. If however, such overseas branch proposes to acquire immovable
property (say office premises) outside India, such acquisition would be regarded as Capital
Account Transaction.
Opening a branch outside India is a permissible current account transaction and regulated
by Notification No. 10/2000-RB dated 3-5-2000 dealing with Foreign Currency accounts by a
person resident in India.
OTHER IMPORTANT SECTIONS – SEC 6(4) AND SEC 6(5):
Section 6(4):
A person resident in India may 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.
However, there was no clarity on the type of transactions that would be covered under section 6(4).
Hence, RBI with a view to resolve the doubts, vide its A. P. (DIR Series) Circular No. 90 dated January
9, 2014 clarified that the following transactions shall be covered under Section 6(4) of FEMA, 1999:
a. Foreign currency accounts opened and maintained by such a person when he was resident
outside India.
b. Income earned through employment or business or vocation outside India taken up or
commenced, or from investments made, or from gift or inheritance received while such a person
was resident outside India.
c. Foreign exchange including any income arising there from, and conversion or replacement or
accrual to the same, held outside India acquired by way of inheritance from a person resident
outside India.
d. A person resident in India may freely utilize all their eligible assets abroad as well as income on
such assets or sale proceeds thereof received after their return to India for making any
payments or to make any fresh investments abroad without prior approval of RBI
Thus, section 6(4) gives liberty to a person resident in India to keep with him any foreign currency or
foreign security or immovable property which he might have acquired when he was resident outside
India, without any compliance and reporting under FEMA.
Section 6(5):
A person resident outside India may 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.
This section allows a person resident outside India to keep with him any currency, security or
immovable property which he might have acquired when he was resident in India. In case if the
person liquidates his investment owned by him in India, he can keep the funds in his NRO account.
RBI vide Notification 13 (Remittance of assets) allows to remit the balances of sales proceeds of
assets held by NRI subject to the limit of USD 1 million per financial year.
