Lot of times NRIs wish to do a loan/gift transaction with their relatives or friends or a reverse way, a resident wants to send money overseas to NRI relatives. It is here that very few people know that such transactions are regulated under FEMA.
Under FEMA, RBI has delegated compliance responsibility to the Authorised Dealer Banks to approve the transaction or not. In practical situation, many a times, there is a difference of opinion between banks too – one bank may be ready to allow your transaction while other bank is not.
Then, there is the Income Tax Act (ITA) angle that you need to ensure: even after transfer of funds, borrower/donee has to maintain sufficient documentation to prove that the credits to the account were genuine funds and not some bogus entries.
In this article, I will try to take up various scenarios and discuss the allowability of transactions in those scenarios. Also, I will present a checklist on what all things to ensure from an ITA compliance point of view.
Of course, please note that this is my own interpretation of FEMA & there can be different interpretations as well so in your interest, please cross-check, discuss and then proceed.
Please note that all though this post, I have used ROI for Person Resident Outside India, RI for Person Resident in India as per FEMA, AL for Asset Liability.
To know your residential status as per FEMA, please first read this post: NRI Definition: FEMA Act VS Income Tax Act
Applicable FEMA regulations on Loan Transactions under FEMA
Following FEMA regulations apply here. All these are available at RBI website Link
- FOREIGN EXCHANGE MANAGEMENT (CURRENT ACCOUNT TRANSACTIONS) RULES, 2000
- FOREIGN EXCHANGE MANAGEMENT (PERMISSIBLE CAPITAL ACCOUNT TRANSACTIONS) REGULATIONS, 2000
- FOREIGN EXCHANGE MANAGEMENT (BORROWING AND LENDING IN RUPEES) REGULATIONS, 2000
- FOREIGN EXCHANGE MANAGEMENT (BORROWING AND LENDING IN FOREIGN EXCHANGE) REGULATIONS, 2000
- FEM (deposit) regulations, 2016
- FOREIGN EXCHANGE MANAGEMENT (remittance of assets) REGULATIONS, 2016-10-20 16
- Master direction on liberalised remittance scheme
- Master direction on other remittance facilities
- Master direction on deposits and accounts
- Master Direction on BORROWING AND LENDING transaction in Indian rupees by person resident in India and non resident indians/person of indian origin
Please note that I have written a separate detailed post on capital and current account transaction – please first read that post: Capital and Current Account Transaction as per FEMA
Various scenerios on NRI loan transactions and allowability under FEMA
Nowlet us discuss one by one various scenerios and applicability of FEMA provisions to those transactions. If I have missed any scenario, please let me know, I will incorporate it.
Scenerio #1: Lender: Mr. A (ROI); Borrower: Mr. B (RI); Currency: INR
Example: Mr. A wants to give a loan to Mr. B by transferring Rs. 1 lac from his NRO/NRE account in India.
- In this case, the AL position of A in India changes with this transaction hence it is a capital account transaction.
- The transaction is permissible vide clause (e) of Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000
- The transaction is allowed by Reg. 4 of FEM (Borrowing and Lending in Indian Rupees) Regulations, 2000 however it is subject to conditions as follows:
- Loan has to be through inward remittances from overseas account/debit to NRE/FCNR etc.
- Loan is on a non-repatriation basis – that means, borrower cannot credit the lender’s NRE/overseas account for repayment
- Rate of Interest on loan cannot exceed 2 percentage points over bank rate
- Period of loan has to be max. 3 years
- The loan amount cannot be used for certain purposes like chit fund/nidhi/agricultural/plantation activities/TDR/capital investment etc.
Other points to note:
- Loan can be given by PIO also, no restrictions. However, loan from foreign nationals is not allowed.
- It is not necessary that a close relative relationship exists between lender and borrower.
Scenerio #2: Lender: Mr. A (ROI); Borrower: Mr. B (RI); Currency: USD
Example: Mr. A wants to give a loan to Mr. B by transferring USD 10,000 from his Citibank USA checking account to Mr. B’s checking account in same bank.
- In this case, the AL position of Mr. A in India as well as Mr. B outside India changes with this transaction hence it is a capital account transaction.
- The transaction is permissible vide clause (e) of Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000
- The transaction is allowed by Reg. 6(4) of FEM (Borrowing and Lending in Foreign Exchange) Regulations, 2000 however it is subject to conditions as follows:
- The amount of loan should be max. USD 2,50,000 (it is not mentioned if this is per financial year – I will interpret it is an overall ceiling, not per financial year as we have in LRS)
- Loan has to be through inward remittances from overseas account/debit to NRE/FCNR
- Lender is close relative of borrower (close relative as per Section 6 of Companies Act)
- Loan is free from interest
- Period of loan has to be minimum 3 years
- The loan amount cannot be used for certain purposes like chit fund/nidhi/agricultural/plantation activities/TDR/capital investment etc.
Points to note:
- Here, it needs to be understood that though RBI allows the transaction per-se, it does not allow overseas account to account transfer – Mr. A has to first bring the USD to India by transferring to an Indian account, and then through that account, it can be transferred to a Mr. B’s account in India/outside India. So, as per my understanding, RBI wants you to take a long cut.
- In this case, nothing is mentioned on the citizenship of lender: can we assume that lender can be a PIO? I think yes. What about foreign national – I think it will be difficult to practically assume a close relative as a foreign national.
- There is no condition that loan has to be on a non-repatriable basis – So I will assume it can be repatriated back to the lender.
Scenerio #3: Lender: Mr. A (RI); Borrower: Mr. B (ROI); Currency: INR
Example: Mr. A wants to give a loan to Mr. B by transferring INR 10,00,000 from his resident savings account in ICICI Bank to Mr. B’s checking account in Citibank USA.
- In this case, the AL position of Mr. B in India changes with this transaction hence it is a capital account transaction.
- The transaction is permissible vide clause (e) of Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000
- The transaction is permissible vide clause (e) of Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000
- The transaction is allowed by Reg. 8B of FEM (Borrowing and Lending in Indian Rupees) Regulations, 2000 however it is subject to conditions as follows:
- loan is free of interest and the minimum maturity of the loan is one year
- loan can only be given to a Non Resident Indian and that too, a relative
- loan amount should be within the overall limit under the Liberalised Remittance Scheme per financial year (USD 250000 as of now) as available for a resident individual.
- loan shall be utilised for meeting the borrower’s personal requirements or for his own business purposes in India;
- loan shall not be utilised for activities like chit fund, Nidhi Company, agricultural/ plantation activities, real estate business, TDR
- loan amount should be credited to the NRO a/c of the NRI/PIO. Credit of such loan amount may be treated as an eligible credit to NRO a/c;
- loan amount shall not be remitted outside India; and
- repayment of loan shall be made by way of inward remittances/ debit to NRO/NRE FCNR/ out of the sale proceeds of the shares or securities or immovable property against which such loan was granted.
Points to note:
- Here, it needs to be understood that though RBI allows the transaction per-se, it does not allow Mr. A to credit it directly to Citibank USA account of Mr. B. Instead, Mr. A will transfer the funds to Mr. B’s NRO account. Also, FEMA Remittance Regulations do not allow Mr. B to transfer this money overseas/to NRE account and thus this borrowing is practically non-repatriable for Mr. B.
- In this case, the word NRI has not been defined. However, it can be assumed that borrower cannot be a PIO/foreign national.
- It is necessary that a close relative relationship exists between lender and borrower. Hence, loan to an NRI friend will not be allowed.
Scenerio #4: Lender: Mr. A (RI); Borrower: Mr. B (ROI); Currency: USD
Example: Mr. A wants to give a loan to Mr. B by transferring USD 10,000 from his checking account in Citibank USA to Mr. B’s checking account in Citibank USA.
- In this case, the AL position of Mr. A in India changes with this transaction hence it is a capital account transaction.
- The transaction is permissible vide clause (e) of Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000
- There is no specific provision for this transaction in FEM (Borrowing and Lending in Foreign Exchange) Regulations, 2000.
In my view, since this transaction is allowed as a capital account transaction but there is no specific mention in BLFE regulations, and hence it is a grey area.
My personal view is looking at the macro scheme of things in FEMA, though RBI allows RI to maintain bank accounts in India & hold money in those accounts, it would not be very happy to allow RIs to stretchy that liberty to do overseas bank to bank transfer.
Hence, I strongly suggest that you should seek a prior approval/clarification from RBI before conducting such a transaction & don’t assume that everything is allowed unless explicit prohibition is there. Other option that can be explored is to transfer INR from a resident account, which is expressly allowed as discussed in Scenario # 3.
Scenario #5: Lender: Mr. A (ROI); Borrower: Mr. B (ROI); Currency: INR
Example: Mr. A wants to give a loan to Mr. B by transferring INR 10,00,000 from his NRE/NRO account in ICICI Bank India to Mr. B’s NRE/NRO account in ICICI Bank India.
- In this case, the AL position of Mr. A as well as Mr. B in India changes with this transaction hence it is a capital account transaction.
- The transaction is NOT permissible under Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000.
- There is no specific provision for this transaction in FEM (Borrowing and Lending in Rupees) Regulations, 2000.
In my view, such a transaction is not allowed under FEMA. If you still wish to go ahead, I will advise to seek a specific prior approval of RBI. Another workaround that Mr. A can do an overseas to overseas bank account transfer to Mr. B which will not fall in the purview of FEMA.
Scenerio #6A: Lender: Mr. A (ROI); Borrower: Mr. B (ROI); Currency: USD
Example: Mr. A wants to give a loan to Mr. B by transferring USD 10,000 from his checking account in Citibank USA to Mr. B’s checking account in Citibank USA.
- In this case, AL position of Mr. A as well as Mr. B in India does not change with this transaction hence it is a current account transaction.
- The transaction is not specifically prohibited under FEM (Current Account Transactions) Rules, 2000.
- There is no specific provision for this transaction in FEM (Borrowing and Lending in Foreign Exchange) Regulations, 2000.
In my view, since both Mr. A and Mr. B are ROI and there are no INR funds involved here, you can go ahead without any restriction from FEMA.
Scenerio #6B: Lender: Mr. A (ROI); Borrower: Mr. B (ROI); Currency: USD
Example: Mr. A wants to give a loan to Mr. B by transferring INR 10,0,000 from his USD denominated FCNR account with ICICI Bank India to Mr. B’s NRE/NRO/FCNR account in HDFC Bank India.
- In this case, AL position of Mr. A as well as Mr. B in India changes with this transaction hence it is a capital account transaction.
- The transaction is NOT permissible under Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000.
- There is no specific provision for this transaction in FEM (Borrowing and Lending in Foreign Exchange) Regulations, 2000.
In my view, this transaction is not allowed under FEMA & in such a situation, if you still wish to go ahead, I will advise you to seek a specific permission of RBI.
Important Note from an ITA perspective
As an NRI, or even a resident, you need to be prepared to explain the sources of credits in your bank accounts because in case of a scrutiny, if you’re not able to explain the source of the credit, the Assessing Officer can treat the credit entry as a “cash credit” by applying Section 69 of ITA and including it as income. Further, he can impose a penalty of upto 200% on tax sought to be evaded, citing concealment of income.
Off late, there has been a lot of overreach by ITD as evident from a recent story in Economic Times also Link
In such situations, it is advisable to execute a loan agreement on plain paper in duplicate which sets out clear terms and conditions on the loan in compliance with FEMA conditions as discussed above. Both parties should also attach some identification proofs like PAN, Passport etc. with the loan agreement.
This can help in case of an income tax scrutiny assessment so that at that time, instead of running around to prove the genuineness of donor, you can simply present this written documentation to the Assessing Officer.
As regards taxability of interest income (unless the loan is interest free), definitely you have to consider the same and offer the income in your tax returns.
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