Foreign Exchange Management Act (FEMA)

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.

What is FEMA Act?

The Foreign Exchange Management Act (FEMA), enacted in 1999, is an Indian law designed to facilitate external trade and payments while promoting the orderly development and maintenance of the foreign exchange market in India. FEMA replaced the earlier Foreign Exchange Regulation Act (FERA) and aims to liberalise the foreign exchange regime in the country.

FEMA provides a framework for the regulation of foreign exchange transactions, ensuring that they are conducted in a transparent and orderly manner. It governs various aspects such as foreign investments, foreign currency accounts, and remittances, allowing individuals and businesses to engage in cross-border transactions with greater ease.

The Act also establishes the Reserve Bank of India (RBI) as the primary authority for overseeing foreign exchange management and enforcing compliance. Additionally, FEMA imposes penalties for contraventions, ensuring adherence to regulations and safeguarding the integrity of India's foreign exchange market. Overall, the FEMA Act plays a crucial role in facilitating economic growth and enhancing India's integration into the global economy.

Also read: What is a Hindu Undivided Family

Highlights of FEMA Act 1999

The Foreign Exchange Management Act (FEMA) of 1999 is a pivotal legislation in India that regulates foreign exchange transactions and promotes the orderly development of the foreign exchange market. Here are some key highlights of the FEMA Act:

1. Liberalisation of Foreign Exchange Transactions

FEMA liberalizes the foreign exchange regime, allowing individuals and businesses to engage in foreign exchange transactions with fewer restrictions compared to the previous FERA.

2. Regulatory authority

The Reserve Bank of India (RBI) is designated as the primary regulatory authority responsible for administering FEMA. It oversees all foreign exchange-related activities and ensures compliance with the Act.

3. Current account transactions

Under FEMA, most current account transactions, such as remittances for education, travel, and medical expenses, are allowed without prior approval from the RBI, facilitating smoother transactions for individuals and businesses.

4. Capital Account Transactions

The Act distinguishes between current and capital account transactions, with capital account transactions requiring RBI approval to maintain a balance between inflows and outflows of foreign exchange.

5. Penalties for Contravention

FEMA establishes penalties for violations, ensuring strict adherence to the regulations. Offenders may face fines or legal actions for non-compliance.

6. Foreign investments

FEMA encourages foreign investments in India by providing clear guidelines and procedures, thereby promoting economic growth and enhancing investor confidence.

7. Reporting requirements

The Act mandates certain reporting requirements for foreign exchange transactions, ensuring transparency and accountability in cross-border dealings.

These highlights reflect the significance of the FEMA Act in enhancing India's foreign exchange framework and its role in fostering economic stability and growth.

Also read: Different types of investments

History of the Foreign Exchange Management Act

The Foreign Exchange Management Act (FEMA) was established in India in 1999 to replace the Foreign Exchange Regulation Act (FERA) of 1973. This transition marked a significant shift in India's approach to foreign exchange from a regime of control to one of management. The change was part of a broader liberalization of India's economic policies initiated in the early 1990s, aimed at facilitating external trade and payments and promoting the orderly development and maintenance of the foreign exchange market in India.

FERA, enacted during the era of strict forex controls, aimed to conserve India’s foreign exchange and prevent misuse by regulating certain activities. However, as India moved towards a more globalized economy, the need for a less restrictive yet effective regulation became apparent. FEMA came into effect on June 1, 2000, with the objective of facilitating external trade and payments and promoting orderly management of the forex market. It focused more on management rather than control, reducing the restrictions on foreign transactions and making the penalties for infringements less severe compared to FERA.

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.

Also read: What is dearness allowance

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

Features of FEMA

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.

Importance of FEMA Act 1999

The Foreign Exchange Management Act (FEMA) of 1999 is pivotal for managing India's foreign exchange transactions and fostering economic growth. Its importance can be underscored through several critical aspects:

1. Regulatory Framework

FEMA provides a clear regulatory framework that governs foreign exchange transactions, ensuring that these transactions are conducted in a structured and transparent manner. This regulatory clarity promotes confidence among investors and businesses.

2. Encouragement of Foreign Investment

By simplifying and liberalizing the process for foreign investments, FEMA attracts global investors to the Indian market. This influx of foreign capital contributes significantly to the country's economic development and enhances its global economic standing.

3. Stabilising Currency Fluctuations

FEMA helps manage the supply and demand for foreign currency, thereby stabilizing the value of the Indian rupee. A stable currency is crucial for maintaining investor confidence and encouraging international trade.

4. Promoting Economic Growth

By facilitating smoother foreign exchange transactions, FEMA supports economic growth. The Act enables easier remittances for trade and investment, which are vital for boosting local businesses and creating jobs.

5. Safeguarding National Interests

The provisions under FEMA protect India's national interests by regulating foreign exchange flows and preventing illegal transactions, thus ensuring that the country’s economic security is upheld.

In summary, the FEMA Act is essential for maintaining a robust foreign exchange management system, thereby playing a crucial role in India’s economic progress.

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What is the role of FEMA?

1. Encouraging foreign investment: FEMA establishes transparent and well-defined regulations, making India a favorable destination for foreign investors and companies. This clarity fosters confidence and promotes a steady inflow of foreign investments.
2. Ensuring economic stability: By regulating and overseeing foreign investments and transactions, FEMA helps maintain economic stability. It minimizes the risk of sudden capital outflows that could disrupt the financial system.
3. Supporting individuals abroad: FEMA provides guidelines to individuals, such as students studying overseas or professionals working abroad, on effectively managing their earnings, savings, and investments within India. This ensures compliance and ease in managing cross-border finances.

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

 

Scope of the FEMA Act

The Foreign Exchange Management Act (FEMA) applies to the following entities and areas:

1. Geographical Scope: FEMA is applicable across India and extends to Indian-owned or managed entities operating abroad.
2. Regulatory Authority: The act is enforced by the Enforcement Directorate, headquartered in New Delhi.
3. Key Areas Covered:
   • Foreign Exchange and Securities: Regulates transactions involving foreign exchange and foreign securities.
   • Trade of Goods and Services: Covers the export and import of commodities and services.
   • Public Debt Securities: Includes securities governed under the Public Debt Act of 1994.
   • Asset Transactions: Governs the purchase, sale, and exchange of assets.
   • Financial Services: Applies to banking, financial, and insurance services.
   • Overseas Entities: Regulates companies with 60% or more ownership by Non-Resident Indians (NRIs).
   • Indian Nationals: Applicable to Indian citizens residing within the country or abroad, including NRIs.

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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