Foreign Exchange Management Act (FEMA)

The Foreign Exchange Management Act, enacted in December 1999, was established to consolidate and amend India's foreign exchange laws.
Foreign Exchange Management Act (FEMA)
3 min
04-July-2024

The Foreign Exchange Management Act (FEMA) is a Parliament of India act passed in 1999 to promote international payments and trade. Its primary objective is to manage the foreign exchange market in India. This act replaced the older Foreign Exchange Regulation Act (FERA) and addressed several of its drawbacks and loopholes.

Since its introduction, FEMA has helped India use its foreign exchange resources more efficiently. This act is also aligned with the guidelines of the World Trade Organisation (WTO), thereby making it easier to conduct international business and manage foreign currency transactions.

Let’s understand the FEMA Act of 1999 in detail and learn its several key provisions.

Objectives of FEMA

The primary motive behind establishing FEMA was to:

  • Facilitate external trade and payments
    and
  • Develop and maintain an orderly forex market

It is important to note that FEMA sets out the formalities and procedures for managing foreign exchange transactions, which are usually categorised into:

  • Current account transactions
    and
  • Capital account transactions

Basically, FEMA manages the transactions that are recorded in both these accounts. For more clarity, let’s understand both of these accounts individually:

Current account

  • It majorly covers transactions related to the:
    • Trade of goods and services
      and 
    • Income and transfers
  • These transactions reflect a country's economic status.
  • Furthermore, the capital account also records financial transactions of investments and loans, including both:
    • Domestic investments abroad
      and
    • Foreign investments in the country
  • Also, FEMA divides the current account transactions into three categories, which are:
    • Transactions prohibited by FEMA
    • Transactions requiring the Central Government’s approval
    • Transactions needing permission from the Reserve Bank of India (RBI)

Capital account

  • It shows the inflow and outflow of money from trade and services.
  • This account tracks the movement of capital in and out of the economy.

Applicability of FEMA Act

It is worth mentioning that the FEMA Act applies:

  • Across all of India.
  • To all Indian citizens (whether they reside in India or abroad).
  • To all Indian entities operating abroad.
  • To all overseas companies owned by NRIs (Non-Resident Indians), if the NRI owns at least 60% of the company.

The main office, called the Enforcement Directorate, is in New Delhi. FEMA governs various activities, such as:

  • Foreign exchange
  • Foreign securities
  • Export and import of goods and services
  • Securities defined under the Public Debt Act, and
  • All forms of financial transactions like banking and insurance

Also read: How to save tax for salary above 15 lakh

Main features of Foreign Exchange Management Act, 1999 (FEMA Act)

To understand the FEMA Act of 1999 better, let’s look at some of its main features:

  • Regulation by the central government
    • FEMA grants the central government the authority to regulate foreign exchange.
  • Authorised persons
    • Financial transactions involving foreign exchange or securities must be conducted by "Authorised Persons" with FEMA's approval.
    • Some common examples of authorised persons are:
      • Authorised dealers
      • Money changers
      • Offshore banking units
  • Transaction categories
    • Foreign exchange transactions are divided into:
      • Capital account transactions (investments, loans)
        and
      • Current account transactions (trade of goods and services)
  • Balance of payments
    • FEMA tracks the balance of payments (BOP)
    • For those unaware, the balance of payments records economic transactions between:
      • India
        and
      • The rest of the world
  • RBI authority
    • FEMA allows the Reserve Bank of India (RBI) to:
      • Determine specific categories of capital account transactions
        and
      • Set exchange restrictions for these transactions in consultation with the Indian government
  • Capital account liberalisation
    • FEMA includes provisions for the gradual liberalisation (easing of restrictions) of capital account transactions.
  • Provisions concerning returning residents
    • FEMA allows individuals who lived abroad and then returned to India to own, hold, and transfer real estate or foreign securities acquired while living outside India.

Categories of authorised persons under the FEMA Act

As per the FEMA Act, financial transactions that involve foreign exchange can be conducted only by "authorised persons" after obtaining approval. These authorised persons are divided into four different categories, each allowed a different set of permitted activities.

Let’s understand them better through the table below:

Categories

Authorised persons

Permitted activities

Category I

  • Commercial banks
  • State Co-operative banks
  • Urban Co-operative banks

All current and capital account transactions as per RBI directives

Category II

  • Upgraded Full Fledged Money Changers (FFMCs)
  • Commercial banks
  • Regional Rural Banks (RRBs)
  • Co-operative banks

All FFMC-approved activities and current account transactions not related to commerce

Category III

Select financial and other institutions

Transactions related to foreign exchange

Category IV

  • Urban Co-operative banks
  • Department of Post
  • Other FFMCs

Purchase and sale of foreign currency for personal and professional travel abroad

 

Structure of FEMA

The organisational structure of FEMA has been carefully designed to ensure that FEMA's regulations are strictly implemented across different regions of India. Let’s look at the structure of FEMA's offices:

Head office

  • The main office of FEMA is called the Enforcement Directorate.
  • It is located in New Delhi and is led by the Director.

Zonal offices

  • There are five zonal offices of FEMA in India.
  • These are located in:
    • Chennai
    • Delhi
    • Mumbai
    • Kolkata
    • Jalandhar
  • Each of these offices is managed by a Deputy Director.

Sub-zonal offices and field units

  • Each zonal office is divided into seven sub-zonal offices.
  • Each sub-zonal office is headed by an Assistant Director.
  • Additionally, there are five field units in each zone, led by Chief Enforcement Officers.

Also read about: Section 80C

Foreign Exchange Management Act penalties

If someone violates the provisions of FEMA or any related rule/ notifications/ circulars, they can be fined up to:

  • Three times the amount involved in the violation
    or
  • Rs. 2 lakh, whichever is higher

In the cases of continuing violation, the person can be fined an additional amount of up to Rs. 5,000 for each day the violation continues.

Prohibition on drawal of foreign exchange

It must be noted that "drawal of foreign exchange" refers to the process of withdrawing or using foreign exchange (forex) for various purposes, such as:

  • Travel
  • Business transactions
  • Investments abroad, or
  • Any other approved uses as per regulations set by the FEMA

As per the FEMA Act of 1999, there are certain transactions where you cannot withdraw foreign exchange. Let's check them out:

Lottery winnings

  • You cannot send money abroad if it comes from winning a lottery.

Income from racing

  • Money earned from activities like horse racing or riding cannot be sent out of the country.

Buying lottery tickets

  • You cannot send money abroad to:
    • Buy lottery tickets
    • Participate in football pools
    • Put money in sweepstakes (casino)
    • Purchase banned magazines

Export commission for investments

  • Commissions paid on exports that are used for equity investment in Indian companies' joint ventures or wholly-owned subsidiaries abroad are prohibited.

Dividend remittance

  • Companies cannot send dividends abroad if they are required to balance their dividend payments according to the applicable rules.

Export commissions on rupees state credit routes

  • Commissions on exports under these routes are restricted.
  • As an exception, up to 10% commission for exports of tea and tobacco is allowed.

Call back services

  • Payments for "call back services" (telephone services where you get a cheaper rate by calling back) are not allowed.

Travel to Bhutan and Nepal

  • You cannot use foreign exchange to travel to Bhutan or Nepal.

Interest on NRSR Accounts

  • Interest earned on funds in Non-resident Special Rupees (NRSR) scheme accounts cannot be sent abroad.

Transactions with residents of Bhutan or Nepal

  • Transactions with residents of Bhutan or Nepal are restricted.

Also read: Section 56 of Income Tax Act

Route for drawal of foreign exchange

According to the Reserve Bank of India (RBI), foreign exchange can be drawn from any authorised dealer using either:

  • The Prior Approval Route
    or
  • The General Permission Route

Once withdrawn, this foreign currency can be used to make different transactions. However, there are certain transactions where the usage of foreign currency has been limited. These limitations are usually put in place to ensure that foreign exchange transactions are appropriately controlled to:

  • Maintain economic stability
    and
  • Compliance with national financial policies

Let’s check out such transactions:

S. No.

Transactions

Limits and conditions

1

Private visits to any country (except Bhutan and Nepal)

Up to 10,000 USD or equivalent per year

2

Donations/Gifts per donor

Up to 125,000 USD per financial year

3

Corporate donations

Limit:

  • Up to 1% of forex earnings in the previous 3 financial years
    or
  • 5 million USD, whichever is less

4

Going abroad for employment

 

Up to 100,000 USD, one-time only

5

Remittance facility for Emigration

Limit:

  • Up to 100,000 USD
    or
  • The prescribed amount by the country of emigration, one time only

6

Maintenance of close relatives outside India

Limit:

  • Salary (after deductions)
    or
  • Up to 100,000 USD per year per recipient in other cases

7

Business travel abroad

Up to 25,000 USD per trip

8

Attending specialised training or conferences

Up to 25,000 USD

9

Medical treatment abroad

Up to 100,000 USD

10

Maintenance of patients for medical treatment abroad

Up to 25,000 USD

11

Studying abroad

Limit:

  • Up to 100,000 USD per academic year
    or
  • As estimated by the institution, whichever is higher

12

Expenses for the person accompanying a patient abroad

Up to 25,000 USD

13

Commission to an agent outside India for selling property located in India

Limit:

  • Up to 25,000 USD
    or
  • 5% of inward remittance per transaction, whichever is higher

14

Consultancy services that are received from outside India

  • For infrastructure projects, the limit is from 1 million USD per project to 10 million USD per project
  • For all other cases, the limit is 1 million USD

15

Pre-incorporation expenses reimbursement

Limit:

  • Up to 100,000 USD
    or
  • 5% of investment brought into India, whichever is higher

16

Purchase/use of trademarks

Allowed without RBI approval

17

Health insurance from a foreign company

Freely allowed

18

Royalty payments and lump sum fees under technical collaboration

Freely allowed without RBI approval

19

Medical treatment abroad when fallen sick

Up to 100,000 USD on a self-declaration basis

20

Small value remittance

Up to 25,000 USD (Form A2)


In addition to the transactions mentioned above, there are several other transactions that require approval from the Central Government, such as:

  • Cultural tours
  • Advertisements in foreign print media (except for tourism promotion, international bidding, and foreign investments) exceeding 10,000 USD by State Government and Public Sector Units
  • Payment for importation by
    • Public Sector Units
      or
    • Government departments (on a CIF basis through ocean transport)
  • Freight remittance for chartered vessels
  • Detention charges for containers (exceeding prescribed rates by the Director General of Shipping)
  • Prize money/sponsorship for sports activities abroad (except for national/international/state-level sports bodies exceeding 100,000 USD)
  • Hiring charges for transponders
  • Internet Service Providers
  • TV Channels
  • Remittance for P&I Club membership
  • Remittance by multi-modal transport operators to their foreign agents

Also read: Section 43B of Income Tax Act

What are the major provisions covered in FEMA, 1999?

The main goal of FEMA is to facilitate external trade and maintain the foreign exchange market in India. For this purpose, the FEMA Act provides several rules for dealing with foreign exchange. Let’s check out some major provisions:

  • Regulation of current account transactions
    • Under the FEMA Act, all current account transactions are generally permitted unless specifically restricted by the central government.
    • Also, some transactions, such as remittances for lottery winnings, are prohibited, while a few require specific approval from the Reserve Bank of India (RBI).
  • Regulation of capital account transactions
    • Under the FEMA Act, capital account transactions are generally prohibited unless expressly permitted.
    • Some examples of permitted transactions are:
      • Foreign direct investments (FDIs)
        and
      • External commercial borrowings (ECBs)
  • Authorised persons
    • All financial transactions involving foreign exchange must be conducted through "authorised persons" designated by the RBI.
    • These entities are classified into different categories based on the scope of activities they are permitted to undertake.
  • Export of goods and services
    • Export proceeds must be realised within six months from the date of shipment.
    • Also, there are specific provisions for extending this period under certain circumstances.
  • Possession and retention of foreign currency
    • FEMA allows residents to possess foreign currency within specified limits (USD 2,000).
    • Also, it states that any unutilised foreign exchange must be surrendered within a stipulated period.

Difference between FERA and FEMA

FEMA’s older version was FERA (Foreign Exchange Regulation Act), whose primary goal was to prevent the misuse of foreign exchange and conserve it. This was due to the scarcity of foreign exchange in India when FERA was enacted.

Gradually, this aim shifted to facilitating external trade and payments and promoting the development and maintenance of a healthy foreign exchange market in India. This led to the establishment of FEMA in 1999, which replaced FERA.

For more clarity, let’s understand some key differences between these acts:

Parameters

FERA

FEMA

Main goal

Prevent misuse and conserve foreign exchange

  • Facilitate foreign trade and payments
  • Develop the foreign exchange market

Primary focus

Exchange regulation and control.

Foreign exchange management

Nature of offence

Violation was a criminal offence

Violation is a civil offence


Conclusion

The Foreign Exchange Management Act (FEMA) was enacted by the Parliament of India in 1999. The Act applies to all Indian citizens and mandates penalties for non-compliance. The primary goal of FEMA is to facilitate international payments and trade while managing the foreign exchange market in India.

Replacing the older Foreign Exchange Regulation Act (FERA), FEMA addresses the modern needs of India's liberalised economy. It divides foreign exchange transactions into current and capital accounts and regulates them via distinct provisions.

Some key provisions of FEMA include the regulation of transactions, the role of authorised persons in handling foreign exchange, and specific guidelines for export proceeds and possession of foreign currency.

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Frequently asked questions

What is the meaning of the Foreign Exchange Act?

The Foreign Exchange Management Act (FEMA) is a law enacted to regulate foreign exchange and ensure orderly management of foreign currency in India. Launched in 1999, it replaced the older Foreign Exchange Regulation Act (FERA) and covered all its loopholes.

What is the benefit of Foreign Exchange Management Act?

FEMA protects national interests by facilitating external trade and maintaining forex market stability. By doing so, it prevents financial crises and undue volatility.

What is FEMA and its features?

In India, FEMA regulates foreign exchange transactions and facilitates external trade. Also, to simplify compliance requirements, it distinguishes between capital and current account transactions,

What is the penalty for FEMA?

Under FEMA, penalties for infringements include fines up to three times the amount involved in the infringement, or Rs. 2 lakh, whichever is higher. Additional penalties amounting to Rs. 5,000 per day also apply for continuing violations.

What are the six components of FEMA?

The six components of FEMA's national preparedness system include identifying and assessing risk, estimating capability requirements, planning to deliver capabilities, validating capabilities, and reviewing and updating plans as needed.

What is the main point of FEMA?

The main objective of FEMA is to facilitate external trade and payments and maintain the foreign exchange market in India in an orderly manner.

What is the scope of FEMA?

FEMA regulates foreign exchange transactions between India and the rest of the world. It covers cross-border transactions, investments, and repatriation of funds.

Who regulates FEMA?

FEMA is regulated by the Reserve Bank of India (RBI) and the Central Government. This Act provides a legal framework for managing foreign exchange transactions and ensures compliance with India’s foreign trade policies.

What are the major provisions of FEMA?

Some major provisions of FEMA include allowing free current account transactions, regulating capital account transactions, managing foreign exchange reserves, and ensuring legal compliance in forex dealings.

What is prohibited under the FEMA Act?

FEMA prohibits transactions related to foreign exchange involving winnings from lotteries, gambling, and other prohibited sources. It also restricts NRIs from purchasing agricultural land, plantations, and farmhouses in India.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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