The Foreign Exchange Management Act, 1999 — Practice

Question 1

Explain the fundamental shift in approach between FERA and FEMA, and state FEMA's stated object.

Accepted Answer

FERA, the Foreign Exchange Regulation Act, 1973, treated foreign exchange as a scarce national resource to be conserved and tightly controlled, and it approached transactions with an underlying presumption against them: dealing in foreign exchange without specific permission was ordinarily prohibited, contravention was a criminal offence, and enforcement carried powers of arrest, with the burden in some respects falling on the accused to establish innocence. FEMA, enacted in 1999, reversed the underlying presumption: foreign exchange transactions are ordinarily permitted and subject to management and reasonable regulation rather than prohibition and suspicion, and contravention of its provisions is, save in specified circumstances, a civil offence attracting penalty rather than criminal prosecution. This reorientation reflects India's transition from a foreign-exchange-scarce, import-substituting economy at the time FERA was enacted, to an economy actively seeking integration with global trade and capital flows by the time FEMA replaced it. FEMA's stated object, given in its preamble, is 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 the foreign exchange market in India. Every substantive provision that follows, from the current and capital account permissions to the civil penalty regime, reads consistently with that object.

Question 2

Classify each as a current or capital account transaction: (a) a resident Indian company remits interest due on a foreign loan; (b) the same company acquires equity shares of a company incorporated outside India; (c) a resident individual remits money for his daughter's education abroad; (d) a resident individual opens a foreign bank account and deposits savings into it.

Accepted Answer

The test throughout is whether the transaction alters assets or liabilities, including contingent liabilities, outside India of a person resident in India, or assets or liabilities in India of a person resident outside India; if it does, it is a capital account transaction, and current account transaction is defined residually as a transaction other than a capital account transaction. Item (a), remitting interest due on a foreign loan, is a current account transaction: it is expressly included within the illustrative list as payment due as interest on a loan, and it discharges an income obligation without creating or altering any asset or liability outside India, the liability having already existed. Item (b), acquiring equity shares of a foreign company, is a capital account transaction: it creates a new asset outside India for the resident company, squarely altering its assets outside India. Item (c), remittance for a daughter's education abroad, is a current account transaction, expressly included within the illustrative list covering expenses in connection with foreign travel, education and medical care of parents, spouse and children. Item (d), opening a foreign bank account and depositing savings into it, is a capital account transaction, since it creates a foreign asset, a deposit balance held outside India, for the resident, altering assets outside India even though the underlying purpose is merely to hold savings.

Question 3

An Indian citizen worked in India for the first seven months of the financial year and then left to take up permanent employment in Dubai. Separately, a person on a foreign work visa has been in India for 200 days this financial year on a fixed six-month project, due to leave shortly. Determine the FEMA residential status of each, contrasting the approach with the Income-tax Act.

Accepted Answer

The first person is likely not a person resident in India under FEMA notwithstanding seven months of presence in India this year, because the exclusion for a person who has gone out of India or stays outside India for taking up employment outside India applies from the point of departure, and taking up permanent employment in Dubai is precisely such an event; the exclusion does not require any minimum period abroad before it operates, and once the person has left to take up employment outside India with the clear circumstance of a permanent posting, FEMA treats him as resident outside India going forward, regardless of the days already spent in India during the financial year. The second person is also likely not resident in India despite 200 days of presence, exceeding the 182-day threshold, because the exclusion for a person who has come to or stays in India otherwise than for taking up employment in India, or for any other purpose indicating an intention to stay for an uncertain period, is engaged: the stay is for a defined six-month project with a fixed departure, showing no intention to remain for an uncertain period, so despite the day count the person falls within the exclusion and is not resident in India for FEMA purposes. The contrast with the Income-tax Act is the point of the question: income tax residential status is computed almost mechanically from day counts across the current and preceding years, with limited scope for intention to override the arithmetic, whereas FEMA's test is expressly purpose-driven, and the exclusions can produce a non-resident classification even where the day count alone would suggest residence, and vice versa. A candidate must apply FEMA's own definition and resist importing the tax test.

Question 4

State the three-schedule structure governing restrictions on drawal of foreign exchange for current account transactions, and give the type of restriction attaching to each.

Accepted Answer

Section 5 permits any person to sell or draw foreign exchange to or from an authorised person for a current account transaction, subject to such reasonable restrictions as the Central Government may impose in consultation with the Reserve Bank, and those restrictions are organised into three schedules of the Foreign Exchange Management (Current Account Transactions) Rules. Schedule I lists transactions for which drawal of foreign exchange is prohibited altogether, such as remittance out of lottery winnings, remittance of income from racing or riding or any other hobby, and remittance of dividend by any company to which the requirement of dividend balancing is applicable. Schedule II lists transactions requiring prior approval of the Government of India, meaning the relevant ministry or department concerned, before foreign exchange may be drawn, covering matters such as cultural tours and advertisement expenditure exceeding specified limits by an entity other than those actively engaged in export promotion. Schedule III lists transactions requiring prior approval of the Reserve Bank of India where they exceed prescribed monetary limits, such as private visits, gift or donation remittances, and business travel beyond specified ceilings, while remaining freely permitted below those ceilings. The structure reflects the general orientation of the Act: current account transactions are permitted by default, and the schedules identify the exceptions in graduated order from an outright bar to a mere approval requirement above a threshold.

Question 5

State the default rule on capital account transactions and the role of the Reserve Bank of India in giving it content. How does this differ in structure from the current account regime?

Accepted Answer

Section 6 provides that, subject to the specified provisions, any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction, but this general permission is given content by the Reserve Bank of India, which in consultation with the Central Government specifies the classes of capital account transactions that are permissible, the limit up to which foreign exchange is admissible for such transactions, and any prohibition, restriction or regulation of capital account transactions. In practice, therefore, a capital account transaction is permitted only if it falls within a class the Reserve Bank has specified as permissible and within any limit so specified, which is functionally closer to a positive list of what is allowed than to the current account regime's negative list of what is restricted. The structural difference is significant and worth stating explicitly: current account transactions are permitted as the default, with three schedules carving out prohibitions and approval requirements for identified categories, so that anything not on a schedule is simply free; capital account transactions depend on the Reserve Bank having affirmatively specified the class as permissible in the first place, so the default posture is closer to management by a positive framework than to a general freedom qualified by exceptions, even though section 6 is drafted in permissive language. This reflects that capital flows, affecting reserves and exchange rate stability more directly than current payments, are managed more actively.

Question 6

A person who was resident outside India for many years, and who owns a foreign bank account and foreign shares, becomes resident in India. Advise on whether these must be liquidated. State the mirror rule for a resident who becomes non-resident.

Accepted Answer

The foreign bank account and shares need not be liquidated. FEMA provides that 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 was inherited from a person who was resident outside India. Having acquired the account and the shares while resident outside India, the person may continue to hold, own, transfer or invest in them after becoming resident in India without a fresh permission being required for the continued holding, which is a deliberate accommodation preventing the change of residential status itself from forcing a disruptive liquidation of assets lawfully acquired. The mirror rule operates for the opposite change of status: a person resident outside India may similarly hold, own, transfer or invest in Indian currency, security or 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 was inherited from a person resident in India. So a person who emigrates from India and becomes non-resident may continue to hold Indian bank deposits, securities and property acquired while resident in India, again without that continued holding itself being a contravention, though ongoing transactions in relation to such assets remain subject to the Act's other provisions and the applicable regulations.

Question 7

A company contravenes FEMA in a transaction involving ₹40 lakh, quantifiable, and the contravention continues for 20 days after the first day of default. Compute the maximum penalty exposure, and explain the compounding option available.

Accepted Answer

Where the amount involved in a contravention is quantifiable, the penalty may extend to thrice the sum involved in the contravention, so on 40 lakh the maximum ordinary penalty is 1.2 crore. Where the contravention is a continuing one, a further penalty may be imposed which may extend to 5,000 rupees for every day after the first day during which the contravention continues; with the contravention continuing for 20 days after the first day, that adds up to a further 1 lakh at the maximum daily rate. The maximum aggregate exposure on these facts is therefore 1.2 crore plus 1 lakh, that is 1.21 crore, though the Adjudicating Authority has discretion up to these ceilings and is not bound to impose the maximum. In addition, any currency, security or other money or property in respect of which the contravention has taken place is liable to confiscation, which is a separate consequence from the monetary penalty. The company has the option of compounding the contravention: any contravention may, on an application made by the person committing the contravention, be compounded within one hundred and eighty days from the date of the application, by the officers specified for the purpose, on payment of such sum as may be determined; once compounded, no further proceeding shall be initiated or continued against the person in respect of the contravention so compounded. Compounding is generally the preferable route where the company wants certainty and finality rather than exposure to the full adjudicatory process and its ceiling.

Question 8

A company contravenes FEMA in a foreign remittance transaction. Its managing director was in charge of and responsible for the conduct of the business at the relevant time. Its company secretary, who had no role in the transaction, is alleged to have been negligent in not flagging a compliance gap. Advise on the liability of each, and on the defence available to the managing director.

Accepted Answer

Two distinct routes to liability under section 42 apply to these two officers, and they must be kept separate. The managing director's liability arises from the first limb: where a contravention is committed by a company, 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 itself, is deemed to be guilty of the contravention and liable to be proceeded against and punished accordingly. A managing director in charge of business at the relevant time falls squarely within this description and is prima facie liable along with the company. He has a statutory due diligence defence, however: no person is liable to punishment if he proves that the contravention took place without his knowledge, or that he exercised all due diligence to prevent it. If the managing director can show either that he did not know of the contravening transaction, or that he had taken all reasonable steps that a person in his position could take to prevent it, he escapes liability notwithstanding his general responsibility for the business. The company secretary's position arises, if at all, from the second limb, which is separate from and does not depend on being in charge of the business generally: where it is proved that the contravention took place with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, that person is also deemed guilty. Mere allegation of negligence in flagging a compliance gap is not itself proof of neglect attributable to the contravention, and liability requires the neglect to be shown, on the facts, to have been a real contributing cause; if established, the company secretary would be liable on this separate ground even without having been in charge of the business generally, and the due diligence defence would similarly be open to him.

Question 9

Trace the appellate structure from an order of the Adjudicating Authority to the highest forum available, stating the time limit for the final appeal and the ground on which it lies.

Accepted Answer

An order of the Adjudicating Authority imposing a penalty for contravention may be appealed. In certain matters, an appeal against orders passed by Assistant Directors and Deputy Directors of Enforcement lies to the Special Director (Appeals), a further tier of appellate authority. From an order of the Adjudicating Authority generally, or from an order of the Special Director (Appeals) where applicable, an appeal lies to the Appellate Tribunal for Foreign Exchange, a specialised tribunal constituted under the Act to hear appeals in foreign exchange matters. From the order of the Appellate Tribunal, a further appeal lies to the High Court, but this final appeal is confined in scope: it lies only on any question of law arising out of such order, not on questions of fact, reflecting the ordinary principle that a specialised tribunal's factual findings, arrived at after a full hearing on the merits, are not to be reopened before a court except where a genuine question of law is shown. The appeal to the High Court must be filed within sixty days from the date of communication of the decision or order of the Appellate Tribunal to the appellant, subject to the High Court's discretion to condone delay on sufficient cause being shown. This structure — adjudication, specialised appellate tribunal, and a law-only appeal to the High Court — is a common pattern in Indian regulatory statutes, and recognising it here helps recall it in analogous contexts across the paper.

Question 10

State the role of the Directorate of Enforcement and the powers available to its officers in investigating a suspected FEMA contravention.

Accepted Answer

The Directorate of Enforcement is the agency responsible for the investigation of contraventions under FEMA, and the Central Government appoints a Director of Enforcement and such other officers as it thinks fit for the purposes of investigating contraventions under the Act. This function is investigative and preparatory rather than adjudicatory: the Directorate builds the case that is then placed before the Adjudicating Authority, which alone determines whether a contravention has occurred and imposes the penalty, keeping the investigating and adjudicating functions institutionally separate. For the purpose of investigation, officers of the Directorate of Enforcement, and any officer of customs or central excise authorised in this behalf by the Central Government, are vested with such of the powers of a civil court under the Code of Civil Procedure, 1908 as may be prescribed, which typically include summoning and enforcing the attendance of any person and examining him on oath, requiring the discovery and production of documents, and receiving evidence on affidavits. The Directorate additionally has power to enter and search any building or place where it has reason to believe any contravention has been or is being committed, and to seize documents in the possession of any person suspected to have committed a contravention, subject to prescribed conditions and safeguards intended to prevent arbitrary exercise of the power.

Question 11

Explain the role of an authorised person under FEMA, how a person becomes one, and on what grounds the authorisation may be revoked.

Accepted Answer

An authorised person is the gateway through which almost every ordinary foreign exchange transaction under FEMA must pass: the Act permits sale or drawal of foreign exchange for current and capital account transactions specifically to or from an authorised person, and no person other than an authorised person may deal in or transfer any foreign exchange or foreign security to any person who is not an authorised person, so the authorised person functions as the licensed intermediary standing between the ordinary transacting public and the foreign exchange market. Authorised person means an authorised dealer, money changer, off-shore banking unit or any other person for the time being authorised by the Reserve Bank to deal in foreign exchange or foreign securities. A person becomes authorised on application to the Reserve Bank, which may grant the authorisation subject to such conditions as it thinks fit to impose, having regard to the object of the Act. The Reserve Bank may revoke an authorisation already granted if it is satisfied that it is in the public interest to do so, or that the authorised person has failed to comply with a condition subject to which the authorisation was granted, or has contravened any of the provisions of the Act or any rule, notification, direction or order made under it, subject to the authorised person being given a reasonable opportunity of being heard before revocation, reflecting the ordinary requirement of natural justice attaching to the withdrawal of a licence or authorisation.

Question 12

State the obligation of an exporter of goods under FEMA regarding declarations to the Reserve Bank, and the purpose it serves.

Accepted Answer

Every exporter of goods is required to furnish to the Reserve Bank, or to such other authority as may be specified, a declaration in the prescribed form containing true and correct material particulars, including the amount representing the full export value of the goods, or where the full export value is not ascertainable at the time of export, the value which the exporter, having regard to the prevailing market conditions, expects to receive on the sale of the goods in the overseas market. The exporter must also furnish such other information as may be required by the Reserve Bank for the purpose of ensuring the realisation of the export proceeds by such exporter. The purpose of this obligation is to enable the Reserve Bank to monitor and ensure that foreign exchange earned through India's export trade is actually repatriated to India rather than being retained abroad, since export proceeds are one of the principal legitimate sources of foreign exchange inflow and a mechanism for their diversion or retention outside India would undermine the very object of orderly development and maintenance of the foreign exchange market that FEMA exists to serve. This declaration requirement is why exporters routinely deal with authorised dealer banks that monitor and follow up on outstanding export bills, and unrealised export proceeds beyond the prescribed period are themselves treated as a matter requiring explanation or regularisation.

Question 13

Define foreign exchange and foreign security under FEMA, and explain, with an example, how an instrument denominated in Indian currency can nonetheless fall within the definition of foreign exchange.

Accepted Answer

Foreign exchange means foreign currency and includes deposits, credits and balances payable in any foreign currency, drafts, travellers' cheques, letters of credit or bills of exchange expressed or drawn in Indian currency but payable in any foreign currency, and drafts, travellers' cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India but payable in Indian currency. Foreign security means 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 where the redemption or any form of return such as interest or dividend is payable in Indian currency. The inclusion in both definitions of instruments that mix currencies is deliberate: a draft expressed or drawn in Indian currency but payable in foreign currency is included as foreign exchange precisely because the ultimate settlement crosses into a foreign currency, and it would defeat the object of managing cross-border currency movement if such an instrument escaped the definition merely because it was denominated in rupees at the drafting stage. For example, a bill of exchange drawn in India, expressed in rupee terms, but stipulated to be payable to the holder in US dollars on presentation abroad, is foreign exchange under this extended definition, because what matters for FEMA's regulatory purpose is where and in what currency the obligation is ultimately discharged, not the currency in which the instrument happens to be denominated on its face.

Question 14

A resident Indian company (a) pays interest on a foreign currency loan; (b) invests in a wholly-owned subsidiary abroad; (c) receives a payment from a non-resident buyer, but retains it in a foreign account instead of repatriating it, contravening a directive requiring repatriation within a prescribed period, and continues to do so for 30 days after the deadline before rectifying; the amount involved is ₹25 lakh. Classify (a) and (b), and compute the penalty exposure for (c), naming the authority that would adjudicate.

Accepted Answer

Transaction (a) is a current account transaction, falling within the illustrative category of payments due as interest on loans, and being an income payment rather than one that creates or alters any asset or liability outside India; it does not fall within any prohibited Schedule I category and is drawable from an authorised person in the ordinary course, subject only to any generally applicable restriction. Transaction (b) is a capital account transaction, since investing in a wholly-owned foreign subsidiary alters the assets outside India of the resident company by creating a new foreign asset, its equity investment in the subsidiary, and it is permissible only within the classes and limits the Reserve Bank has specified for outward investment by residents, typically under the relevant overseas investment regulations. Transaction (c) is a contravention: failing to repatriate export or other proceeds within the prescribed period, and retaining foreign exchange abroad in breach of a repatriation requirement, is a contravention of the Act and the regulations governing realisation and repatriation of foreign exchange. The amount involved, 25 lakh, is quantifiable, so the penalty may extend to thrice that sum, that is up to 75 lakh, and because the contravention continued for 30 days after the deadline before rectification, a further penalty may be imposed extending to 5,000 rupees for each of those days, adding up to 1.5 lakh at the maximum rate, giving a maximum aggregate exposure of 76.5 lakh, subject to the Adjudicating Authority's discretion within that ceiling and to confiscation of the money in respect of which the contravention took place. The Adjudicating Authority appointed by the Central Government would hold the inquiry and, if satisfied a contravention occurred, impose the penalty, with a right of appeal to the Appellate Tribunal for Foreign Exchange.

Question 15

A person is found to have acquired foreign currency in contravention of FEMA. The Adjudicating Authority imposes a monetary penalty. Advise on whether the currency itself may additionally be seized, and state the relationship between penalty and confiscation.

Accepted Answer

The currency may additionally be confiscated, and confiscation operates alongside the monetary penalty rather than as an alternative to it. Where any contravention has taken place, any currency, security or other money or property in respect of which the contravention has taken place is liable to confiscation, and this liability arises from the contravention itself rather than from the quantum of penalty separately determined; the Adjudicating Authority, on being satisfied that a contravention has occurred, may direct confiscation of the currency, security or other money or property in question in addition to imposing the penalty prescribed for the contravention. The two consequences serve different purposes and are not mutually exclusive: the penalty is punitive and deterrent, calibrated to the sum involved in the contravention up to the statutory ceiling of thrice that sum, whereas confiscation strips the contravening party of the specific property that was the subject matter of, or was obtained through, the unlawful transaction, preventing retention of the very asset the contravention was designed to secure. A person facing both consequences on the same facts is not being punished twice for the same wrong in the sense that would offend ordinary principles against double jeopardy, because the penalty addresses the wrongdoing generally while confiscation addresses the specific property connected to it, and the Act contemplates both being imposed together in an appropriate case, subject always to the person's right to be heard and, if aggrieved, to appeal against the Adjudicating Authority's order to the Appellate Tribunal for Foreign Exchange.

Practice — The Foreign Exchange Management Act, 1999

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