Lot of times, there is confusion whether a particular transaction is allowed as per FEMA regulations or not. And it is here that that it is important to first establish whether the account is a capital account transaction or a current account transaction under FEMA.
In FEMA, each transaction has to be classified as either a capital account transaction or a current account transaction and depending on the classification, there are different rules on whether it can be allowed or not.
Today, let us understand the definition and rules around capital/current account transactions in FEMA.
Note: In the post, following acronyms have been used:
ROI: Resident Outside India
RI: Resident In India
Definition of Capital Account Transaction
The term “Capital Account Transaction” is defined in Section 2(e) of FEMA Act. Apart from this definition, there is a separate regulation on it which we’re going to discuss next.
Section 2.
…
(e) “capital account transaction” means 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;
Section 6.
…
(3) Without prejudice to the generality of the provisions of sub-section (2), the Reserve Bank may,
by regulations, prohibit, restrict or regulate the following-
(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 rupees 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 owed to a person resident outside India; or
(ii)by a person resident outside India.
Definition of Current Account Transaction
The term “Capital Account Transaction” is defined in Section 2(j) of FEMA Act. Apart from this definition, there is a separate regulation on it which we’re going to discuss in this post.
(j) “current account transaction” means a transaction other than a capital account transaction and
without prejudice to the generality of the foregoing such transaction 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,
- (ii) payments due as interest on loans and as net income from investments,
(iii) remittances for living expenses of parents, spouse and children residing abroad, and
(iv) expenses in connection with foreign travel, education and medical care of parents, spouse and children;
Basic principle governing current and capital account transactions
So, two important conclusions can be drawn from the examples
- Definition of capital and current account transaction in FEMA is very different from the generally understood accounting/economic definition.
- Facts of each individual case have to be checked before coming to any conclusion.
Following is the basic principle of allowability of a current/capital account transaction as follows:
- A capital account transaction is always prohibited unless otherwise allowed
- A current account transaction is always allowed unless otherwise prohibited
Let us go deep into the logic why it is like this.
RBI wants to ensure that the balance of payments position of the nation as a whole is within control – hence, intention of restricting the capital account transaction is precisely to ensure that.
However, in case of current account transaction, there is no change in the AL position and hence it is freely allowed despite some restrictions which we shall see as we move ahead.
Rules on Capital Account Transaction
4. Prohibition :-
Save as otherwise provided in the Act, rules or regulations made thereunder, no person shall undertake or sell or draw foreign exchange to or from an authorised person for any capital account transaction,
b) 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 –
(i) in the business of chit fund, or
(ii) as Nidhi Company , or
(iii) in agricultural or plantation activities or
(iv) in real estate business, or construction of farm houses or
(v) in trading in Transferable Development Rights (TDRs).
Schedule I: Classes of capital account transactions of Persons resident in India
a) Investment by a person resident in India in foreign securities
b) Foreign currency loans raised in India and abroad by a person resident in India
c) Transfer of immovable property outside India by a person resident in India
d) Guarantees issued by a person resident in India in favour of a person resident outside India
e) Export, import and holding of currency/currency notes
f) Loans and overdrafts (borrowings) by a person resident in India from a person resident outside India
g) Maintenance of foreign currency accounts in India and outside India by a person resident in India
h) Taking out of insurance policy by a person resident in India from an insurance company outside India
i) Loans and overdrafts by a person resident in India to a person resident outside India
j) Remittance outside India of capital assets of a person resident in India
k) Sale and purchase of foreign exchange derivatives in India and abroad and commodity derivatives abroad by a person resident in India.
Schedule II: Classes of capital account transactions of persons resident outside India
a) Investment in India by a person resident outside India, that is to say,
i) issue of security by a body corporate or an entity in India and investment therein by a person resident outside India; and
ii) 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.
b) Acquisition and transfer of immovable property in India by a person resident outside India.
c) Guarantee by a person resident outside India in favour of, or on behalf of, a person resident in India.
d) Import and export of currency/currency notes into/from India by a person resident outside India.
e) Deposits between a person resident in India and a person resident outside India.
f) Foreign currency accounts in India of a person resident outside India.
g) Remittance outside India of capital assets in India of a person resident outside India.
If we analyse this definition, Reg. 4 specifically prohibits certain transactions – for example, you have to go to the Authorised Dealer bank to withdraw foreign exchange for any capital account transaction – this seems to be aimed at hawala practices whereby people try to bypass the banking channels for making overseas transactions, and which is a contravention of FEMA
Secondly, certain business investments like chit fund/nidhi/real estate are a no go for ROIs.
Thirdly, there is an allowed list of transactions in Schedule I and II for RI and ROI respectively. It needs to be remembered that only transactions listed in Schedule will be allowed.
Rules on Current Account Transaction
Rules on Current Account Transactions are mentioned in FOREIGN EXCHANGE MANAGEMENT (CURRENT ACCOUNT TRANSACTIONS) RULES, 2000.
The basic structure of rules is as follows:
- Forex for Nepal/Bhutan: Not allowed
- Forex for transaction with a person with Nepal/Bhutan: Not allowed
- Transactions specified in Schedule I: Not allowed
- Transactions specified in Schedule II: Allowed basis prior approval of Govt. of India
- Transactions specified in Schedule III: Allowed basis prior approval of RBI
Note: For point 4 and 5, no approval is required if payment is made from Resident Foreign Currency (RFC) account or Exchange Earners’ Foreign Currency (EEFC) account
Now, we come to the various schedules:
SCHEDULE I: Transaction which are prohibited
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.
6. Payment of commission on exports under Rupee State Credit Route, except commission up to 10% of invoice value of exports of tea and tobacco
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.
SCHEDULE II: Transactions which require prior approval of the Central Government
1. Cultural Tours: Ministry of Human Resources Development (Department of Education and Culture)
2. Advertisement in foreign print media for the purposes other than promotion of tourism, foreign investments and international bidding (exceeding US$ 10,000) by a State Government and its Public Sector Undertakings: Ministry of Finance, Department of Economic Affairs]
3. Remittance of freight of vessel charted by a PSU: Ministry of Surface Transport (Chartering Wing)
4. Payment of import through ocean transport by a Govt. Department or a Ministry of Surface Transport
5. Multimodal transport operators making remittance to their agents abroad: Registration Certificate from the Director General of Shipping
6. Remittance of hiring charges of transponders by
(a) TV Channels: Ministry of Information and Broadcasting
(b) Internet service providers: Ministry of Communication and Information Technology
7. Remittance of container detention charges exceeding the rate prescribed by Director General of Shipping: Ministry of Surface Transport (Director General of Shipping)
8. Deleted
9. Remittance of prize money/sponsorship of sports activity abroad by a person other than International/National/State Level sports bodies, if the amount involved exceeds US $ 100,000: Ministry of Human Resource Development (Department of Youth Affairs and Sports)
10. Deleted
11. Remittance for membership of P & I Club Ministry of Finance (Insurance Division)
SCHEDULE III: Transactions requiring approval of RBI
This schedule says that for the below purposes, no RBI approval is required if the remittance is within limit of USD 250000 in a financial year:
- Private visits to any country except Nepal and Bhutan
- Gift
- Donation
- Going abroad for employment
- Emigration
- Maintenance of close relatives abroad
- Travel for business/conferences abroad
- Expenses for meeting medical expenses abroad or for accompanying as an attendant to patient
- Studies abroad
- Any other current account transaction
For point no. 4, 7, 8: Actual expenses are allowed and limit of USD 2,50,000 does not apply. However, in such cases, you need to provide the documentation/proof in terms of medical estimates, college fee schedule etc. to the AD bank to prove the genuineness of the requirement.
For points other than no. 4, 7, 8: Prior RBI approval will be required if expenses is > USD 250000 for a particular year.
It may also be noted that the USD 2,50,000 is also popularly known as “Liberalised Remittance Scheme (LRS)” andis covered by a separate Master Direction. I have discussed LRS in greater detail in a separate post: Returning NRIs: Know about Liberalised Remittance Scheme
AG note: For transactions listed in Schedule I, even if the payment is from RFC/EEFC accout, you cannot make these transactions. Also, there are some special provisions in current account rules for facilities for non-individuals and expats – for the sake of brevity, I have not mentioned those here.
Understanding Capital and Current account transactions with examples
If we analyse this definition, the most important thing for a transaction to constitute capital account transaction is that whether it changes anything to the net worth of
Example # 1:
ROI Mr. A gives a gift from his overseas bank account to a RI Mr. B.
Does this change the assets and liabilities of Mr. A in India? NO. Hence, the transaction is NOT a capital account transaction – it will be a current account transaction (which we’ll discuss later in the post)
Example # 2:
ROI Mr. A gives a gift from his NRO bank account in India to a RI Mr. B.
In such a case, there will be two entries in Mr. A’s books as follows:
Capital A/c Dr.
To B
(Being gift to B)
B Dr.
To Bank Account
(Being amount transferred to the account of B)
In this transaction, since there is a clear reduction of capital on liabilities side as well as current assets on debt side of Mr. A’s balance sheet in India, this transaction will qualify as a capital account transaction.
Example # 3:
ROI Mr. A gives a loan from his NRO bank account in India to a RI Mr. B.
In such a case, there will be following two entries in Mr. A’s books as follows:
Loan A/c Dr
To B
(Being loan to B)
B Dr.
To Bank Account
(Being amount transferred to the account of B)
In this transaction, there is a clear change in the values of the current assets (advances as well as bank accounts of Mr. A’s balance sheet in India. Hence, this transaction will qualify as a capital account transaction
Example # 4:
Mr. A, an RI, sends money from his resident bank account to his brother as a loan Mr. B who is an ROI.
In such a case, there will be following two entries in Mr. A’s books as follows:
Loan A/c Dr
To B
(Being loan to B)
B Dr.
To Bank Account
(Being amount transferred to the account of B)
This case is almost similar to Example # 3 above. However, if you see, in this case, the money is transferred by Mr. A from own resident bank account. So, there is no change in the AL position in outside India balance sheet of Mr. A & hence it would be a capital account transaction.
How to check the allowability of a transaction under FEMA
Especially in FEMA, it is very important to check the regulations on a whole. While on one hand, ROI buying property in India is a capital account transaction allowed under Schedule II, the Master Direction on Acquisition of Immovable Property in India has to be also seen that does not allow buying of agricultural land.
So, if you wish to check the allowability of a transaction in FEMA, you can follow the below step wise process
- Decide whether it is a capital/current account transaction.
- Check vis a vis basic principle of allowability of transaction
- Check the respective rules on capital/current account transactions, as applicable.
- Check the respective rules/circulars/master directions on the applicable transaction for any further restrictions/conditions
What to do if your transaction is not allowed under the FEMA framework
If your transaction does not expressly fall within Schedule (in case of capital account transaction) or falls within the prohibitory schedule in case it is a current account transaction, there is a high chance that it is not allowed under FEMA.
However, Section 3 of FEMA Act says: –
3. Dealing in foreign exchange, etc.– Save as otherwise provided in this Act, rules or regulations made there under, or with the general or special permission of the Reserve Bank, no person shall-
And hence, in such a situation, there is still a door open for you to approach RBI for a specific approval/clarification.
It needs to be noted here that RBI possesses large discretionary powers and if denial in your case will involve a genuine hardship, and RBI officers sense a honesty in your case, then there is a chance they might allow it.
Hence, it is important that if you hire a CA/advocate to represent your case with SEBI, he should present your case effectively and with full honesty and disclosure of facts.
Also note that RBI decisions are non-appealable (except in a rare care you wish to file a writ petition before the High Court) – even there, to the best I know and have heard in my professional circles, Courts have mostly held the RBI view and not gone against it.
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