What is FEMA and its Features

FEMA (Foreign Exchange Management Act,1999) is an Act of the Parliament of India and was passed on 29/12/1999 in parliament, replacing the Foreign Exchange Regulation Act (FERA). The RBI is primary regulatory authority responsible for administration of FEMA.

1) What is FEMA: FEMA is a regulatory mechanism that enables the RBI to pass regulations and the Central Government to pass rules relating to foreign exchange in tune with the Foreign Trade policy of India.

Purpose of Act: Integrate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India.

2) Applicability: Whole of India and it shall also apply to all branches, offices and agencies outside India owned or controlled by a person resident in India and also to any contravention thereunder committed outside India by any person to whom this Act applies.

3) Structure of FEMA:

• Head Office: Situated in New Delhi and known as Enforcement Directorate (ED).
• Zonal Offices: 5 Zonal offices (Chennai, Delhi, Mumbai, Kolkata, Jalandhar) in India and managed by Deputy Director.
• Sub-Zonal offices and field units: Each zonal offices is divided into 7 sub-zonal offices and headed by Assistant Director and there are 5 field units in each zone, led by Chief Enforcement Officers.

4) Summary of FEMA Act:

The FEMA Act consists of 49 sections.

• Section 2 – “Definitions”,
• Sections 3 to 9 – Substantive provisions of the FEMA which lay down the permissions and prohibitions on a person for matters connected with foreign exchange in India.
• All the remaining sections deal with procedures, penalties, powers, etc.
• Section 46 – the Central Government has the power to make Rules to carry out the provisions of the Act.
• Section 47 – the RBI has powers to make Regulations to carry out the provisions of the Act and the Rules.

In addition to FEMA Act, various other FEMA Rules, Regulations, Master Directions, Circulars, FAQs, judgements of Supreme Court and High Court, the decisions of the FEMA Appellate Tribunal and Compounding Orders issued by the Compounding Authority shall also be considered for the interpretation of FEMA provisions. Matters pertaining to Foreign Investment in India, the Foreign Direct Investment Policy and its related press release shall also be considered.

5) History:

FERA was legislation passed in India in 1973. The bill was formulated with the aim of regulating certain kinds of payments and dealings in foreign exchange. FERA came into force with effect from January 1, 1974.

Purpose of introducing FERA Act:

The country was struggling with low foreign exchange reserves. As a result, FERA operated on the assumption that any foreign exchange earned by Indian residents was rightfully the property of the Government of India and had to be collected and handed over to the RBI.

Purpose of Replacing FERA Act:

• Due to various demerits of FERA such as broad powers limited individual and business’s economic freedom, potentially hindering long-term growth by restricting the private sector’s adaptability.
• FERA had strict rules and regulations for foreign exchange transactions, and non-compliance could result in severe penalties and imprisonment.
• FERA Act had become incompatible with the pro-liberalization policies of the Government of India.

Hence, FERA became redundant and was repealed in 1998 by the government of India and replaced by the FEMA, which liberalized foreign exchange controls and restrictions on foreign investment.

6) Benefits of FEMA:

• An offence under FEMA is no longer a criminal offence as it was under FERA.
• FEMA is in consonance with the frameworks of the World Trade Organization (WTO).
• It also enabled the way for the Prevention of Money Laundering Act, 2002 which came into effect from July 1, 2005.
• It liberalizes the usage of foreign exchange with fewer restrictions.

7) Features of FEMA Act:

• The FEMA Act gives authority to the Reserve Bank of India to establish the categories of capital account dealings and exchange restrictions applicable to such dealings in consultation with the Government of India.
• The FEMA empowers the Central Government to regulate foreign exchange activities in India.
• All transactions must be carried out through “Authorised Persons.” This group includes authorized dealers, money changers, and offshore banking units, among others.
• Foreign exchange transactions are classified into two categories: Capital account transactions and Current account transactions.
• FEMA violation allows for arrest only in extreme circumstances.
• It includes provisions related to the gradual liberalization of capital account transactions.

8) Principles of FEMA:

• Capital Account transaction:
  It means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of person resident in India or assets or liabilities in India of person resident outside India. All Capital account transactions are prohibited unless expressly permitted. Some Examples of permitted Capital Account transactions – Foreign Direct Investments (FDI), External Commercial Borrowings (ECB).Any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction.
•  Current Account transaction:
  These are transactions other than capital account transactions. All Current Account transactions are permitted unless specifically prohibited.Current account transaction includes payments for foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business, payments due as interest on loans and as net income from investments, remittances for living expenses of parents, spouse and children residing abroad, and expenses in connection with foreign travel, education and medical care of parents, spouse and children.

  Any person may sell or draw foreign exchange to or from an authorized person if such sale or drawal is a current account transaction.

9) Dealing in foreign exchange:

Every person shall only deal with below if it is specified by FEMA Act or with RBI permission.

• Deal in or transfer foreign exchange or foreign securities to unauthorized persons;
• Receive payments from residents outside India, except through authorized persons;
• Enter into any financial transaction in India related to acquiring or transferring assets outside India.

10) Major Rules of FEMA:

• Inward Investments – “Foreign Exchange Management (Non-Debt Instrument) Rules, 2019” which deals with foreign investment (e.g., Foreign Direct Investment, Foreign Portfolio Investment, Foreign Investment in LLPs, AIF/REITs, NRI Investment, etc.,) in India by a person resident outside India and acquisition of immovable property in India by a person resident outside India.
• Outward Investments – “Foreign Exchange Management (Overseas Investment) Rules, 2022” which deals with overseas investment (e.g., Overseas Direct Investment, Overseas Portfolio Investment, Overseas Investment by an individual, etc.,) by a person resident in India and acquisition of foreign immovable property by a person resident in India.

Understanding FEMA is essential for businesses and individuals engaged in international transactions to ensure compliance with the law and facilitate smooth cross-border activities. It’s advisable to stay updated on any amendments or changes to the legislation.