December 10, 2022

Trade Credit under FEMA

Trade Credit is a very popular term in daily business transactions. Trade Credit is a source of short-term financing wherein the Supplier provides an agreed credit period to the buyer to make payment for the supply of goods or services without any interest.

When it comes to providing Trade Credit within the domestic market, it can be carried out through commercial terms, and no intervention or regulation is required from the government. However, obtaining trade credit from the international market is not free, rather, it is regulated by the Government through Foreign Exchange Management Act (FEMA).

In this article, you will get a brief insight into what is trade credit. and what FEMA regulations related to Trade Credit.

1. Brief About Trade Credit

1.1 What is Trade Credit?

Trade credit is a business-to-business (B2B) agreement in which a customer can purchase goods without paying cash up front, and paying the supplier at a later scheduled date.

Usually, businesses that operate with trade credits policies provide credit periods of 10 days to 90 days to make payment. The credit period is decided as per the internal policies of the business.

1.2 Benefits of Trade Credit to the Supplier

Trade credit is a way to promote sales because buyers are more attracted to such suppliers which provide an option of deferred payment.

Providing trade credit strengthens the supplier-customer relationship and generally prevents buyers from moving to some other supplier.

Since trade credit puts suppliers at somewhat of a disadvantage, many suppliers use discounts when trade credits are involved to encourage early payments. A supplier may give a discount if a customer pays within a certain number of days before the due date.

For example, a 2% discount if payment is received within 10 days of issuing a 30-day credit. This discount would be referred to as 2%/10 net 30 or simply just 2/10 net 30.

1.3 Benefits of Trade Credit to the buyer

Trade credit can be thought of as a type of 0% financing, increasing a company’s assets while deferring payment for a specified value of goods or services to some time in the future and requiring no interest to be paid in relation to the repayment period.

A B2B trade credit can help a business to obtain, manufacture, and sell goods before ever having to pay for them. This allows businesses to receive a revenue stream that can retroactively cover the costs of goods sold.

Walmart is one of the biggest utilizers of trade credit, seeking to pay retroactively for inventory sold in their stores.

The number of days for which a credit is given is determined by the company allowing the credit and is agreed upon by both the company allowing the credit and the company receiving it.

1.4 What Are the Types of Trade Credit

Trade credits can come in the form of open accounts, promissory notes, or bills payable:

An open account is an informal agreement where the seller sends the goods and an invoice to the buyer.
A promissory note is a formal agreement where the buyer agrees to the terms, including the payment date, and signs and returns the document to the seller.
Bills payable refer to financial instruments drawn by the seller and accepted by the buyer with an agreement of payment on the expiry date.

2. Trade Credit From international market – Master Guidelines

Section 6 of the Foreign Exchange Management Act provides a list of Capital Account transactions. As per Section 6(3)(d) of FEMA, the Reserve Bank of India may prohibit, restrict or regulate any borrowing or lending in foreign exchange.

Trade Credit obtained from the international market is a form of Capital Account transaction and pursuant of Section 6(3)(d), the same is regulated by RBI.

Master Direction – External Commercial Borrowings, Trade Credits, and Structured Obligations (“ECB Master Directions”) are issued by RBI vide RBI/FED/2018-19/67 FED Master Direction No.5/2018-19 dated 26th March 2019. These master directions are issued in suppression of earlier issued Master Direction date 1st January, 2016.

Key Highlights of ECB Master Directions are as follows:

2.1 Meaning of Trade Credit under FEMA

As per Para 13 of ECB Master Directions, Trade Credits (TC) refers to the credits extended by the overseas supplier, bank, financial institution, and other permitted recognized lenders for maturity, for imports of capital/non-capital goods permissible under the Foreign Trade Policy of the Government of India. Depending on the source of finance, such TCs include suppliers’ credit and buyers’ credit from recognized lenders.

The key highlights of the ECB Master Direction are set out below :

2.2 Trade Credit (TC) Framework

TC Limits: Following Trade Credits are permitted under the automatic route:
1. Trade Credits can be raised up to USD 150 Million per import transaction in relation to oil/gas refining and marketing, airline, and shipping companies.
2. In other cases, TCs can be raised up to USD 50 million or its equivalent per import transaction.

Form of TC: Trade Credits are of two types namely Suppliers’ Credit and Buyers’ Credit. In both cases, a credit facility is provided to the Indian Customer. However, the person providing the credit varies.
- Buyers’ Credit: Under this facility, finance for the import of goods in India is provided by a bank or financial institution situated outside India in the following manner:
  - Indian customers approach a foreign bank or foreign branch of an Indian bank or any foreign financing institution for providing credit facilities.
  - Such foreign entity grants financing to the importer based on a guarantee given by the Importer’s Bank.
  - On purchase of goods, the foreign entity makes immediate payment to the foreign supplier and the Importer can make payment to the foreign entity within the agreed time.
- Supplier’s Credit: Under this facility, credit is provided by the supplier himself instead of any bank or financial institution.

Denomination of TC: TCs can be raised in any freely convertible foreign currency (TC Denominated in FCY) or Indian Rupees (TC denominated in INR). Further, a change of currency of TC from FCY to any other freely convertible foreign currency or INR is freely permitted. However, a change of currency from INR to any freely convertible foreign currency is not permitted.

Further, for a change of FCY TC to INR TC, the exchange rate prevailing on the date of the agreement between the parties concerned for such change or at an exchange rate, which is less than the rate prevailing on the date of the agreement, if consented to by the TC lender.

For conversion to Rupee, the exchange rate shall be the rate prevailing on the date of settlement.

Eligible Borrower: Any person resident in India and acting as an importer can raise TC. Further, TCs can also be raised by:
1. a unit or developer in an SEZ (including a Free Trade Warehousing Zone (‘FTWZ’)) for the purchase of capital or non-capital goods within an SEZ including FTWZ; and
2. an entity in a Domestic Tariff Area for the purchase of capital or non-capital goods from a unit or developer of an SEZ including FTWZ.
3. Further, in the case of sales transactions within SEZ, no bill of entry is involved. Therefore, the inter-unit receipt generated through NSDL can be treated as an import document.

Recognized Lender :
1. Buyers’ credit: Banks, financial institutions, foreign equity holders located outside India, and financial institutions in International Finance Service Centers located in India can provide TC. Foreign branches/subsidiaries of Indian banks are permitted as recognized lenders only for FCY TC.
2. Suppliers’ Credit: Supplier of goods

Period of TC: Following is the permitted period of TC:
1. Import of capital goods: TC can be raised for up to 3 years.
2. Import of Non-capital Goods: the period is capped at 1 year or the operating cycle, whichever is less.
3. In the case of shipyards/shipbuilders: the period of TC for the import of non-capital goods is up to three years.

All-In-Cost: All-in cost refers to the cost of financing, i.e., the cost incurred by the importer for obtaining Trade Credit. For TC, All-in-Cost shall include the rate of interest, other fees, expenses, charges, and guarantee fees whether paid in foreign currency or INR. Withholding tax payable (TDS) in INR shall not be a part of all-in-cost. Further, TC proceeds cannot be used for payment of interest/charges. Following is the AIC ceiling per annum:
1. TC Denominated in FYC: For existing TCs linked to LIBOR whose benchmarks are changed to ARR, Benchmark rate plus 350 bps spread. For new TCs, Benchmark rate plus 300 bps spread
2. TC Denominated in INR: Benchmark rate plus 250 bps spread.

Security for TC: Foreign Banks or Financial institutions have no knowledge about the Financial position of the importer. Therefore, they need security for providing Trade Credit to the importer. TCS can also be secured by:
- Bank Guarantee:
  1. AD banks provide bank guarantees in favor of overseas lenders on behalf of the importer for an amount not exceeding the TC;
  2. Overseas guarantees issued by foreign banks or overseas branches of Indian banks.
  3. The period of such a guarantee cannot be beyond the maximum permissible period for TC.
- Other Security: The importer may also offer the security of movable assets (including financial assets) / immovable assets (excluding land in SEZs) / corporate or a personal guarantee for raising trade credit.

2.3 Reporting Requirement of Trade Credits:

Following reporting is mandatory for Trade Credits:

Monthly Reporting:
- AD Category I banks are required to furnish details of TCs like drawal, utilization, and repayment of TC approved by all its branches during a month. Such details should be furnished in Form TC to the Director, Division of International Trade and Finance.
- The form should be filed in MS Excel file through email.
- The statement should reach not later than the 10th of the following month.
- Each TC shall be given a unique identification number by the AD bank.

Quarterly Reporting:
- AD Category I banks are also required to furnish details of bank guarantees issued for TCs by all its branches.
- Such details should be filed in a consolidated statement, at quarterly intervals on the XBRL platform.

2.4 Responsibility of adherence to provisions

Primarily responsibility for adhering to the TC policy lies with the importer.
However, the ADs Banks are also expected to ensure compliance with applicable parameters of the trade credit policy/provisions of the Foreign Exchange Management Act, 1999 by their constituents.
Further, RBI has not prescribed any format or manner in which TC arrangements/loan agreements are to be documented. Therefore, ADs may consider any document to satisfy themselves with the underlying TC arrangement.
ADs should make sure that there is no double financing on account of these transactions has been taken place.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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