IMPORTANT CONCEPTS UNDER FEMA

INTRODUCTION

Foreign Exchange Management Act, 1999 (FEMA) replaced Foreign Exchange Regulation Act, 1973 (FERA) with effect from 1^st June 2000. The replacement was a great sigh of relief for the people as FERA was unduly stringent in its criminal provisions. FEMA is a civil law and proactive in its outlook compared to FERA. The thrust of FEMA is to "manage" the scarce foreign exchange resources of the country rather than to "control" them as was prevalent under FERA. FEMA met the need of the day in the changed economic scenario of India, especially since 1991.

APPLICABILITY OF FEMA

FEMA is applicable to the whole of India.

The expression "whole of India" would indicate that the provisions of the Act are applicable to all transactions taking place in India. Thus, any person who is present in India at the time of transaction has to comply with the provisions of FEMA.

FEMA is applicable to all branches, offices and agencies outside India owned or controlled by a person resident in India. Thus, FEMA has retained its extra-territorial jurisdiction, as under FERA.

Illustration: If an Indian Company opens a branch in New York, U.S.A., that branch will become resident of India and, therefore, all restrictions applicable to Indian residents for overseas transactions are equally applicable to such a branch. Then right from opening of a bank account to entering into any transaction of capital nature (e.g., acquisition of premises), it will need prior approval from RBI (subject to exemptions/general permissions granted by RBI under various Notifications).

RESIDENTIAL STATUS

One of the important changes in FEMA relates to the "Residential Status of a Person".

The terms "person" and "person resident in India" are defined under sections 2(u) and 2(v) of FEMA, respectively. Ironically, like FERA, FEMA, too, does not define the term Non-resident. Section 2(w) defines "person resident outside India" as a person who is not resident in India. (For all practical purposes, the term "person resident outside India" is synonymous with the term "non-resident" and these terms are used interchangeably in this book). Let us look closely at these two important definitions under FEMA: -

Definition of "Person"

Section 2(u) "Person" includes-

(i) an individual,

(ii) a Hindu Undivided Family (HUF),

(iii) a company,

(iv) a firm,

(v) an association of persons (AOP) or a body of individuals (BOI), whether incorporated or not,

(vi) every artificial juridical person, not falling within any of the preceding sub-clauses, and

(vii) any agency, office or branch owned or controlled by such person." 

Explanation.- The above definition is similar to the definition of "person" under Section 2(31) of the Income Tax Act, with some minor differences like exclusion of local authority and inclusion of category (vii) above. This definition is unique to FEMA, not found under FERA. The idea evidently is to provide clarity about its applicability and extend its coverage.

"Person Resident in India" 

Section 2 (v): The term "person resident in India" means

(i) a person residing in India for more than one hundred and eighty-two days during the course of the preceding financial year but does not include -

(A) a person who has gone out of India or who stays outside India, in either case -

(a) for or on taking up employment outside India, or

(b) for carrying on outside India a business or vocation outside India, or

(c) for any other purpose, in such circumstances as would indicate his intention to stay outside India for an uncertain period;

(B) a person who has come to or stays in India, in either case, otherwise than -

(a) for or on taking up employment in India, or

(b) for carrying on in India a business or vocation in India, or

(c) for any other purpose, in such circumstances as would indicate his intention to stay in India for an uncertain period;

(ii) any person or body corporate registered or incorporated in India,

(iii) an office, branch or agency in India owned or controlled by a person resident outside India,

(iv) an office, branch or agency outside India owned or controlled by a person resident in India;

Explanation

An attempt has been made to link the definition of the person resident In India (PRI) under FEMA with the definition of that term under the Income-tax Act 1961, by providing the criteria of physical stay of 183 days or more in India, in so far as individuals are concerned.

Practical Aspects

(I) First of all, "Financial Year" is not defined under FEMA.

For the sake of understanding, we assume it to be from 1^st April to 31^st March, being the official year of the Government of India. Secondly, the Income-tax Act requires physical presence of 182 days or more, whereas, FEMA requires 183 days or more. Thirdly, the term " residing in India" is not defined. We may assume that it is equivalent to physical presence in India.

Under FERA, a person's residential status was determined based on his intention alone, rather than his physical presence in India. FEMA has attempted to blend the two different definitions as prevailed under FEMA and the Income-tax Act 1961, resulting in confusion.

(II) The Income-tax Act considers the physical presence of a person in the current financial year for determining his tax liabilities of the current year, whereas FEMA considers physical presence of a person in the preceding financial year, with the result that a person might have to wait for one and a half year to become resident in India.

Consider the following illustration: -

Mr. Sangwan comes to India after a continuous stay abroad for 2 years. During the financial year 2003-2004, i.e. from 1^st April 2003 to 31^st March 2004 his stay was less than 183 days. Assuming that he stays in India through out the financial year 2004-2005, he would be a non-resident under FEMA for the financial year 2004-2005 notwithstanding the fact that he was in India for more than 182 days, as his presence in India during the preceding financial year, i.e. 2003-2004 was for a period of less than 183 days.

In order to avoid this anomaly, the definition of a "Person resident in India" needs to be interpreted in a manner in a manner that leads to a logical conclusion.

DETERMINATION OF THE RESIDENTIAL STATUS UNDER FEMA

Individuals

In order to make a definition of a person resident in India workable one has to look first at the exceptions given in clauses (A) and (B) and if the person is not falling under either of them, then look at his physical presence in India during the preceding financial year. Thus, in effect, the criteria, for determination of residential status of a person under FERA based on "facts and intentions", are retained under FEMA, too, as it is evident from the examples given herein below:

Examples:

Mr. Mishra leaves India on 1^st December 2004 for taking up employment outside India for the first time. What will be his residential status?

Mr. Mishra will be considered as a non-resident, w.e.f. 1^st December, 2004 irrespective of the fact that he was residing in India for more than 182 days in the preceding financial year (i.e. 2003-2004), for the reason that he is covered by Exception (A) (a) of the definition.

Mrs. Katrina a foreign citizen of non-Indian Origin sets up a proprietary concern in India on 1^st June 2004 for carrying on business. What will be his residential status for the financial Year 2004-2005?

The situation is covered by exception B (b). Mrs. Katrina will be considered as resident in India w.e.f 1^st June 2004 as he came to India for carrying on business, irrespective of the fact that he has not at all stayed in India during the preceding financial year (i.e. F.Y 2003-2004).

Mr. Singh, who is staying in Dubai for more than ten years, has to come to India on 1^st July 2003 for medical treatment. He has not visited India during F.Y. 2002-2003. He is planning to return to Dubai after medical treatment is over. Doctors have advised him to stay in India up to 31^st October 2004. What will be his residential status under FEMA?

Mr. Singh is not covered by any of the exceptions laid down under clause (B) as his intention to stay in India is for a specific period. He will be non-resident in F.Y. 2003-2004 notwithstanding his stay exceeding 182 days in the current year, as in the preceding financial year (i.e. F.Y. 2002-2003), he was not in India for 183 days or more. As far as the F.Y 2004-2005 is concerned he would be resident from 1^st April 2004 till 31^st October 2004, (as his stay in F.Y. 2003-2004 would have exceeded 182 days). Mr. Shah would be NR, w.e.f. 31^st October 2004 as he would be leaving India for an uncertain period covered by exception mentioned in clause A(c).

Residential status of a Student leaving for overseas for the purpose of education

A student leaving India for the purpose of further education was treated as a resident by the Reserve Bank of India unless he takes up employment overseas even though his stay in India was less than 183 days. On review of the situation, Reserve Bank has liberalised the provisions as follows:

A student leaving abroad for the purpose of further education would be treated as a Non-resident Indian on the grounds that his stay abroad is for more than 182 days in the preceding financial year and that his intention is to stay abroad for an uncertain period. As a non-resident, the student would be eligible for receiving following remittances from India (Circular No. 45 dated December 8, 2003).

1. up to USD 100,000 from close relatives from India on self-declaration towards maintenance and studies,

2. up to USD 1 million out of sale proceeds/balances in his account maintained with an authorised dealer in India,

3. all other facilities available to NRIs under FEMA,

4. educational and other loans availed of by students as resident in India can be allowed to continue:

Residential Status of Other Entities

Clauses (ii) to (iv) of sub-section (v) of section 2 of FEMA deal with determination of residential status of entities other than individuals.

Clause (ii)

This clause provides that any person or body corporate (say, HUF, FIRM, AOP, BOI, Companies etc.), registered or incorporated in India would be considered as "person resident in India". Here, the emphasis is on the registration or incorporation. A question arises as to what about an unregistered Firm, AOP or BOI or say HUF that recquires no registration? Whether they would be out of the purview of FEMA, although they are included in the definition of person. Here, too, the outcome seems to be unintended. In order to make FEMA workable, it is advisable to consider that FEMA is applicable to such entities.

Clause (iii) 

This clause provides that an office, branch or agency in India owned or controlled by a person resident outside India (PROI) is considered as "resident in India". Even though such entities are treated as resident in India, under section 6(6) of the Act, RBI is empowered to prohibit, restrict or regulate their establishment as well as activities in India. Notification No.FEMA/22/RB-2000 deals with Regulations pertaining to establishment of such entities in India. One difficulty here is that the terms " agency", "ownership" and "control" are not defined.

Clause (iv)

As per this clause, an office, branch or an agency outside India owned or controlled by a person resident in India would be considered as 'resident in India'. This is a significant departure from FERA where under such entities were considered as non-resident. The consequences of this change are far-reaching. Under the scheme of FEMA, transactions are divided into two distinct categories, namely, Current Account and Capital Account transactions. Whilst Current account transactions are by and large freely permitted, a lot of restrictions are placed on Capital Account transactions to be entered into by Indian residents. Therefore, treating such entities as residents in India would pose several unforeseen difficulties.

Consider the following illustrations:

An Indian Company sets up a branch in USA. Such a branch cannot carry out following transactions without RBI's prior approval (the list is just illustrative)

(i) Purchase of any premises (although US laws may be permitting it freely);

(ii) Purchase of any capital assets;

(Vide Notification No. 47/2001-RB dtd. 5-12-2001, RBI has clarified that purchase or acquisition of office equipments and other assets required for normal business operations and other assets required for normal business operations of an overseas branch/office/representative will not be deemed to be Capital Account transactions).

(iii) Borrow or lend money;

(Vide Notification No. 67/2002-RB dtd. 20-08-2002, RBI has permitted Indian Companies to grant rupee loans to their employees, who are NRIs or PIOs).

(iv) Placement or acceptance of deposits.

It will thus be observed that this particular change in FEMA would result in undue hardship as such entities will have to comply with legal requirements of two countries, namely, the "host country" (i.e. where they are operating) as well as the " home country" (i.e. India). Many a time, requirements in either country may be conflicting with each other.

NON- RESIDENT INDIAN (NRI)

Section 2 of the FEMA deals with various definitions. It defines person resident in India and a person resident outside India. However, it does not define the term non-resident nor it defines the term Non-resident Indian (NRI).

However, Notification No. 5/2000-RB (dealing with various kinds of Bank Accounts) defines the term "Non-resident Indian (NRI)" to mean a person resident outside India who is either a citizen of India or is a person of Indian origin. The term PIO has been defined differently in different Notifications and therefore, the term NRI in turn will have a different meaning. In short, one should bear in mind that the definitions of NRI and PIO are contextual.

"Person of Indian Origin" (PIO)

The term "Person of Indian Origin" (PIO) is defined differently in different Notifications and therefore, the term NRI will have a different meaning depending upon the Notification one applies. Therefore, when applying provisions of FEMA, one must be careful about the reference and context of such application.

Different definitions of the term PIO are as follows: -

A. The term PIO as defined under Notification No. 5 (dealing with various kinds of Bank Accounts); Notification No. 13 (dealing with Remittance of Assets) and Notification No. 20 (dealing with Inbound Investments including Foreign Direct Investments (FDI) is as mentioned below:

"Person of Indian origin" means a citizen of any country other than Bangladesh or Pakistan, if- 

(i) he at any time held Indian passport; or

(ii) he or either of his parents or any of his grandparents was a citizen of India by virtue of the of the Constitution of India or the Citizenship Act, 1955 ( 57 of 1955); or

B. The term is defined almost identically as above under the Notification No. 24 (dealing with investment in Firm or Proprietary concern in India) except that the citizens of Sri Lanka are also excluded from the definition in addition to citizens of Bangladesh or Pakistan as mentioned above.

C. The term PIO is defined in the following manner in the Notification no. 21 (dealing with the Acquisition and Transfer of Immovable Property In India):

"Person of Indian origin" means an individual (not being a citizen of Afghanistan, Bangladesh, Bhutan, China, Iran, Nepal, Pakistan, or Sri Lanka) who -

(i) at any time held Indian passport; or

(ii) who or either of whose  father or whose grandfather  was a citizen of India by virtue of the Constitution of India or the Citizenship Act, 1955 ( 57 of 1955)."

It will be thus seen that for the purposes of acuisition or transfer of immovable property in India, persons of Indian origin who are citizens of Afghanistan, Bangladesh, Bhutan, China, Iran, Nepal, Pakistan, or Sri Lanka are excluded from the definition of PIO.

Overseas Corporate Body (OCB)

Like the term NRI, the term " Overseas Corporate Body (OCB)" is also not defined in the Section 2, which deals with definitions of various words/terms in general. Notification No. 5 (dealing with Bank Accounts) and Notification No. 20 (dealing with Inbound Investments) define the term OCB in following manner.

'Overseas Corporate Body (OCB)' means a company, partnership firm, society and other corporate body wholly owned, directly or indirectly, to the extent of at least sixty per cent by Non- Resident Indians and includes overseas trust in which not less than sixty per cent beneficial interest is held by Non-Resident Indians, directly or indirectly but irrevocably.

In order to establish that a particular entity is an OCB, the investor has to furnish a certificate in following forms from the Certified Public Accountant and/or Chartered Accountant of the country to which such entity belongs:

However, RBI has issued Notification No. 101/2003-RB dated October 3, 2003 whereby OCBs holding investments/interests in India as on 16^th September 2003 are derecognised as an eligible "class of investors". Now, OCBs which did not have any investments/interests in India prior to 16^th September 2003 would be treated on par with Foreign Companies. (Refer Annexure V for Circular No. 44 dated December 8, 2003 on Derecognition of Overseas Corporate Bodies (OCBs).

CURRENT ACCOUNT AND CAPITAL ACCOUNT TRANSACTIONS

Under the FERA regime the thrust was on regulation and control of the scarce foreign exchange, whereas under the FEMA, emphasis is on management of foreign exchange resources. Thus, there is a clear shift in focus from control to management. Therefore, under FERA it was safe to presume that any transaction in foreign exchange or with non-resident was prohibited unless it was generally or specially permitted.

FEMA has formally recognised the distinction between Current Account and Capital account Transactions. Two golden rules or principles in FEMA are mentioned below: -

• All Current account transactions are permitted unless otherwise prohibited: and

• All Capital account transactions are prohibited unless otherwise permitted.

CURRENT ACCOUNT TRANSACTIONS

India is signatory to the WTO Agreement. As a part of its obligation under the WTO Agreement, India has relaxed (not removed) its exchange control regulations on Current Account transactions.

The term " Current Account Transaction" is defined u/s 2(j) to mean "a transaction other than a capital account transaction and without prejudice to the generality of the foregoing, such transaction includes:-

1. payments due in connection with foreign trade, other current business, services, and other short term banking credit facilities in the ordinary course of business,

2. payments due as interest on loans and as net income from investments.

3. remittances for living expenses of parents, spouse and children residing abroad,

4. expenses in connection with foreign travel, education and medical care of parents, spouse and children"

Explanation:-

As discussed earlier, this concept is unique to FEMA and was not found in FERA. When it is said that Current Account transactions are free from controls in India, it does not imply that any amount of remittance is permitted for a Current Account Transaction. Section 5 authorizes the Central Government to impose restrictions on Current Account transactions. Exercising this authority, the Central Government has issued Notification No. GSR 381(E) entitled as the F.E.M (Current Account Transactions) Rules, 2000 dated 3^rd May 2000, according to which drawal of foreign exchange is prohibited for:

1. transactions specified in Schedule I, or

2. travel to Nepal and /or Bhutan , or

3. transactions with a person resident in Nepal or Bhutan.

As far as categories (b) and (c) above are concerned, it may be noted that Indian rupee is a widely accepted currency in these countries and hence, drawal of foreign exchange is not permitted for travel to and transactions with these countries.

Schedule II of the said Notification lists transactions, which require prior approval of the Government of India, except when the exchange is drawn from RFC/EEFC, Accounts.

Schedule III of the said Notification lists transactions, which require prior approval of the RBI. In some cases prior permission is required only if the transaction value exceeds the limits specified therein except where the exchange is drawn from RFC/ RFC (D) Accounts.

(Refer Annexure I of this Chapter for items covered by Schedule I, II and III)

Reserves Bank of India has liberalised the remittances permissible under the current account transactions vide Circular No. 76 dated February 24,2004. Following transactions are permissible under the automatic route without any monetary ceiling : -

1. Remittance by Artistes, e.g. wrestler, dancer, entertainer, etc.

2. Remittance for securing Insurance for Health from a company abroad.

3. Short-term credit to overseas offices of Indian companies.

4. Remittance for Advertisement on Foreign Television Channels.

5. Remittance of Royalty and Payment of Lump sum fee provided the payments are in conformity with the norms as per item no. 8 of Schedule II, i.e. royalty does not exceed 5% on local sales and 8% on exports and lump-sum payment does not exceed USD 2 million.

6. Remittance for use of Trademark/Franchise in India.

It may be noted from the above that interest and other income on investments are only covered as Current account transactions. Therefore, the principal amount of investment can be remitted abroad, only if it has been invested on repatriation basis. Any Current account transaction that is not regulated or prohibited is permitted by implication.

Section 2(e) defines "Capital Account Transactions" to mean "a transaction which alters the assets or liabilities, including contingent liabilities, outside India of a person 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." [Refer Annexure 2 for Capital Account Transactions specified in Section 6 (3)].

Section 6 (3) contains ten sub clauses covering a wide range of transactions, namely, Foreign Direct Investments in India, Overseas Direct Investments from India, Borrowing or Lending in foreign exchange and in Indian rupees, various kinds of bank accounts, immovable property in India and abroad, guarantees, etc., for each category, the RBI has issued separate Notifications.

The distinction between the two types of transactions needs to be understood from the viewpoint of 'balance of payments' of the country. There is a difference between our normal understanding of a "Capital asset" or a "Capital expenditure" and a Capital account transaction per se.

For example, import of machinery on payment of cash or on normal credit terms of the vendor will be regarded as the current account transaction. The importer may capitalise it in his account books and claim depreciation thereon. As far as the country is concerned, it is a trade transaction. However, if the same machinery is imported on deferred credit basis or is funded out of ECB etc., the credit beyond twelve months (as less than twelve months again would fall within the definition of "Current account transactions") would result in the creation of the long-term liability outside India and therefore, be termed as a Capital account transaction.

A word of caution here is that, the meaning of " alteration of assets or liabilities" is not properly defined and therefore, leads to different interpretations. In order to be right side of the law. It is advised that in case of doubt, the matter may be referred to the Reserve Bank of India.

ILLUSTRATIVE LIST OF CURRENT AND CAPITAL ACCOUNT TRANSACTION

ANNEXURE I

LIST OF CURRENT ACCOUNT TRANSACTIONS

SCHEDULE - I

 And Other Restrictions
LIST OF CURRENT ACCOUNT TRANSACTIONS FOR WHICH DRAWAL
OF FOREIGN EXCHANGE IS NOT PERMITTED

1. Remittance out of lottery winnings.

2. Remittance of income from racing/riding, etc., or any other hobby.

3. Remittance for purchase of lottery tickets, banned/prescribed magazines, football pools, sweepstakes, etc.

4. Payment of commission on exports made towards equity investment in Joint Ventures/Wholly Owned Subsidiaries abroad of Indian companies.

5. Remittance of dividend by any company to which the requirement of dividend balancing is applicable (The condition of dividend balancing not applicable presently).

6. Payment of commission on exports under Rupee State Credit Route, except commission up to 10% of invoice value of exports of tea and coffee.

7. Payment related to "Call Back Services" of telephones.

8. Remittance of interest income on funds held in Non-resident Special Rupee Scheme A/c.

9. Travel to Nepal and/or Bhutan

10. Transaction with a person resident in Nepal and/or Bhutan (RBI has the power to relax this prohibition).

11. Remittance towards participation in lottery schemes involving money circulation or for securing prize money/awards, etc.

 SCHEDULE-II
LIST OF CURRENT ACCOUNT TRANSACTIONS FOR WHICH PRIOR APPROVAL OF THE GOVERNMENT IS REQUIRED

(No permission required if payment is made out of RFC or RFC (Domestic Account for all types of payments listed in item nos. 1 to 10, whereas for payments out of EEFC Account, no permission is required for transactions listed in item nos. 1 to 9)

SCHEDULE-III
LIST OF CURRENT ACCOUNTS TRANSACTIONS FOR WHICH PRIOR
APPROVAL OF RBI IS REQUIRED

(No permission required if payment is made out of RFC or RFC (Domestic) Account)

1. Release of exchange exceeding US $ 10,000 or its equivalent in one financial year ( April to March), for one or more private visits to any country (except Nepal and Bhutan).

2. Gift remittance exceeding US $ 50,000 per remitter/donor per annum.

3. Donation exceeding US $ 50,000 per remitter/donor per annum.

4. Exchange facilities exceeding US $ 1,00,000 per persons going abroad for employment.

5. Exchange facilities for emigration exceeding US $ 1,00,000 or amount prescribed by country of emigration.

6. (a) Remittance for maintenance of close relatives abroad exceeding net salary (after deduction of taxes, contribution to provident fund and other deductions) of a person who is resident but not permanently resident in India and is a citizen of a foreign state other than Pakistan or is a citizen of India, who is on deputation to the office or branch or subsidiary or joint venture in India of such foreign company.

(b) Exceeding USD 100,000 per year, per recipient, in all other cases.

Explanation: For the purpose of this term, a person resident in India on account of his employment or deputation of a specified duration (irrespective of length thereof) or for a specific job or assignment; the duration of which does not exceed three years, is a resident but not permanently resident.

7.  Release of foreign exchange, exceeding US $ 25,000 to a person, irrespective of period of stay, for business travel, or attending a conference or specialised training or for maintenance expenses of a patient going abroad for medical treatment or check-up abroad, or for accompanying as attendant to a patient going abroad for medical treatment/check-up.

8. Release of exchange for meeting expenses for medical treatment abroad exceeding the estimate from the doctor in India.

9. Release of exchange for studies abroad exceeding the estimates from the institution abroad or US $ 1,00,000 per academic year, whichever is higher.

10. Release of exchange for commission to agents abroad for sale of residential flats/ commercial plots in India, exceeding 5% of the inward remittance per transaction or USD 25,000 whichever is higher.

11. Remittances exceeding US $ 1,000,000 per project for consultancy services procured from abroad subject to the applicant submitting documents to the satisfaction of the authorised dealer.

12. Remittance exceeding US $ 1,00,000 for reimbursement of incorporation expenses.

13. Remittance exceeding US $ 5,000 or its equivalent for small value remittances.

Note : The above restrictions shall not apply on the use of  International Credit Card for making payment by a person towards meeting expenses while such person is on a visit outside India.

ANNEXURE II 

CAPITAL ACCOUNT TRANSACTIONS SPECIFIED IN SECTION 6(3)

Reserve bank may, by regulations, prohibit, restrict or regulate the following types of transactions: -

a) transfer or issue of any foreign security by a person resident in India;

b) transfer or issue of any security by a person resident outside India;

c) transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India;

d) any borrowing or lending in foreign exchange in whatever form or by whatever name called;

e) 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;

f) deposits between persons resident in India and persons resident outside India;

g) export, import or holding of currency or currency notes;

h) transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India;

i) acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India.

j) Giving of a guarantee or surety in respect of any debt, obligation or other liability incurred -

(i) by a person resident in India and owned to a person resident outside India; or

(ii) by a person resident outside India.