Capital Account Transactions under FEMA

Capital Account transactions under FEMA are those transactions which alter the assets or liabilities including  contingent liability, of any person. Change is made in assets or liabilities held outside India of the person who is resident of India or Asset or liability in India of the person who is resident outside India.

Capital Account transactions can  be better understood with following example:

1. Permitted Capital Account Transactions

1.1 Permitted Capital Account Transaction for Person Resident In India (Schedule I read with Regulation 3 of the Regulations)

As per Schedule I read with Regulation 3, a person resident of India is permitted to buy or sell foreign currency for following capital account transactions. Provided that the amount transaction should not exceed permitted threshold.

• Investment by a person resident in India in foreign securities.
• Foreign currency loans raised in India and abroad by a person resident in India.
• Transfer of immovable property outside India by a person resident in India.
• Guarantees issued by a person resident in India in favor of a person resident outside India.
• Export, import and holding of currency/currency notes
• Loans and overdrafts (borrowings) taken by a person resident in India from a person resident outside India. 
• Maintenance of foreign currency accounts in India and outside India by a person resident in India.
• Taking out an insurance policy by a person resident in India from an insurance company outside India.
• Loans and overdrafts by a person resident in India to a person resident outside India.
• Remittance outside India of capital assets of a person resident in India.
• Sale and purchase of foreign exchange derivatives in India and abroad and commodity derivatives abroad by a person resident in India.

Under the Liberalised Remittance scheme (“LRS”), Capital account transactions are permitted upto USD 2,50,000 per financial year without RBI approval. Any capital account transaction above USD 2,50,000 shall require prior approval of RBI.

1.2 Permitted capital Account Transactions for Person resident outside India (Schedule II read with Regulation 3 of the Regulations)

As per Schedule II of the Regulations read with Regulation 3, person resident outside India is permitted to enter into following capital account transaction subject to given threshold limit:

• Investment in India by a person resident outside India, that is to say,
  • Security are issued by a body corporate or an entity in India and investment in such security is made by a person resident outside India; and
  • investment by way of capital contribution by a person resident outside India to the capital of a firm or a proprietorship concern or an association of persons in India.
• Acquisition and transfer of immovable property in India by a person resident outside India.
• Guarantee by a person resident outside India in favor of, or on behalf of, a person resident in India.
• Import and export of currency/currency notes into/from India by a person resident outside India.
• Deposits between a person resident in India and a person resident outside India.
• Foreign currency accounts in India of a person resident outside India.
• Remittance outside India of capital assets in India of a person resident outside India.
• Undertaking derivative contracts.

However, as per Section 6(4) and 6(5) of FEMA Act, Indian currency earned during the year in which person holds the status of “Person Resident In India” and Foreign Currency earned while holding the status of “Person Resident Outside India” can be utilised without any restriction during the the year in which person holds other status, i.e., “Person Resident outside India” or “Person resident in India” respectively. Such transaction shall not be considered for the purpose of computation of Threshold limit of USD 2,50,000 per year.

2. Prohibited Capital Account transactions (Regulations 4)

As per regulation No. 4 of the regulations, no person shall undertake or sell or purchase foreign exchange to or from authorised representative for any capital account transaction. Therefore, unless capital account transaction is covered under Schedule I and Schedule II, all other capital account transactions are prohibited.

Further, as per Regulation No. 4, No person resident outside India shall make investment in India in any entity, where such entity is engaged or proposes to engage –

1. In the business of chit fund, or
2. As Nidhi Company, or
3. In agricultural or plantation activities or
4. In real estate business, or construction of farmhouses or
5. In trading in Transferable Development Rights (TDRs).

3. Power to impose restrictions on Capital Account Transactions (Section 6 of FEMA)

3.1 POWER OF RESERVE BANK OF INDIA

1. As per Section 6(2) of Foreign Exchange Management Act (“FEMA”), Reserve Bank of India, in consultation with  the Central Government, may specify:
   • Capital transactions, involving debt instruments, which are permissible
   • Limit upto which foreign exchange is permissible for such transactions
   • Any additional condition that is required to be fulfilled

2. “Debt instrument” means any transaction as may be determined by the central government in consultation with RBI. 
3. Earlier, Section 6(3) contained a list of capital account transactions which the Reserve Bank of India could have prohibited, restricted or regulated. However, such sub-section got deleted with effect from 15th October, 2019.

3.2 POWER OF CENTRAL GOVERNMENT

1. A new sub-section (2A) has been inserted in Section 6 of FEMA. As per Section 6(2A), Central government, in consultation with RBI, may specify:
   • Capital transactions, not involving debt instruments, which are permissible
   • Limit upto which foreign exchange is permissible for such transactions
   • Any additional condition that is required to be fulfilled

2. Therefore, as per joint reading of Section 6(2) and Section 6(2A) of FEMA, both RBI and Central Government are authorised to frame rules in relation with Capital Account Transactions in consultation with each other.
3. However, with respect to debt instrument, only RBI is authorised to prescribe conditions and limit.
4. Both Reserve Bank of India or the Central Government shall not impose any restrictions on:
   • Payment made for amortisation of loan or
   • Payment made for not depreciation of direct investments in the ordinary course of business
5. For other capital account transactions, a person is free to buy or sell foreign exchange.
6. As per Section 6(4) of FEMA, However, if a “person resident in India” possesses some foreign currency which was earned by him at the time when he was “person resident outside India” or such currency is inherited by him from a person who is resident outside India. In such a case, that foreign currency can be used to hold, own, transfer or invest in foreign currency, foreign security or any immovable property situated outside India. Therefore, no restriction is applicable for foreign currency which was earned while holding the status of person resident outside India.

E.g.

In such a case, during the year 2019, when a person holds the status of resident in India. However, still he can use his foreign currency of $3,00,000 for the purpose of investment in foreign securities, immovable property located outside India etc. This amount was earned by the person when he was resident outside India.

Similarly, if a person resident outside India holds some Indian currency and such currency was earned by him at the time when he was “person resident in India” or such currency was acquired from a person who was “person resident In India”. In such case, that foreign currency can be used for investment in Indian Securities, immovable property in India etc. without any restriction.

4. Regulations on Capital Account Transactions under FEMA

In exercise of power given under Section 6, Reserve Bank of India notified Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 (“The Regulations”). Through this act, RBI has issued following regulations for capital account transactions:

As per Regulation No. 3, Transactions given in Schedule I (Transaction by person resident in India) and Schedule II (transaction by person resident outside India) are permitted. However, transaction amount should not exceed provided threshold limits.

Transactions given in Regulation 4 are completely prohibited.

5. Method of payment for investment

Payment for investment shall be made by either of the following methods:

1. Remittance from abroad through normal banking channels or 
2. By debit to an account of the investor maintained with an authorized person in India.

6. Contraventions and Penalty 

1. As per Section 13 of FEMA, If a person contravene any provisions of FEMA then he shall be liable to pay penalty:
   • upto 3 times of the sum involved in contravention, where amount is quantifiable, or 
   • Upto INR 2,00,000, where the amount is not quantifiable. 
2. In case of continuing default, penalty upto INR 5000 per day shall be levied for all such days during which default continues.
3. In addition to the above mentioned penalty, any currency, security or any other money or property in respect of which contravention has taken place shall be liable for confiscation. Further, foreign exchange holding, if any, of the person who has committed the contravention shall be brought back to Indian or shall be retained outside India.