RBI Guidelines on Merchant Trade Transaction

For the prosperous economy of a country, all types of transactions play a vital role. These days high seas sales and Merchant Trading Transactions have become quite common wherein goods move neither out of India nor it enters into India. Rather, shipment moves from one country outside India to another country outside India and any person from India acts as an intermediary in such a transaction.

Due to the increasing online platforms, these transactions are becoming very common. Even though these transactions neither involve the movement of goods in India nor outside India but these transactions involve the inflow and outflow of foreign exchange in India. Therefore, these transactions are closely regulated by the Reserve Bank of India (“RBI”). 

For the purpose of monitoring Merchant Trading Transactions, RBI has issued guidelines for Merchant Trade Transactions (“MTT”). These guidelines have been amended various times over the period of time based on changes in the market and transactions. The latest guidelines were issued vide circular No. RBI/2019-20/152 A.P. (DIR Series) Circular No.20 dated 23rd January, 2020.

In this article a detailed discussion has been carried out on Guidelines issued by RBI on Merchant Trading Transactions:

1. What is Merchant Trade Transaction (MTT)

• Merchanting trade Transaction is the kind of transaction where the shipment of goods commences from one country outside India and terminates in another foreign country without touching the Domestic Tariff Area (DTA) of India, i.e., the Customs borders of India. Such a transaction is considered a Merchanting Trade Transaction.

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• Example
  • XY Limited is located in India involved in the supply of computers and accessories. The Company received an order for 1000 units of Laptop from a customer located in the USA. 
  • The Company in turn placed such an order as it is with its supplier located in Canada and directed him to deliver the goods directly to the USA without any delivery to India.
  • Since goods in the transactions are not entering into the DTA of India, therefore, this transaction is called as Merchant Trade Transaction.
  • The supply of goods by the supplier to the XY Limited is an “Import Leg”.
  • The supply of goods by XY Limited to the Customer is “Export Leg”.

• As per guidelines issued by The Reserve Bank of India, for a trade to be classified as merchanting trade, goods acquired shall not enter the Domestic Tariff Area.

2. Whether any transformation/modification is allowed in goods supplied under MTT

• As per earlier guidelines on MTT (Circular No. RBI/2013-14/545 A.P. (DIR Series) Circular No.115 dated 28th March 2014), goods supplied under MTT were not permitted to undergo any transformation.
• However, as per revised guidelines, RBI has agreed that in some cases, the goods may require certain specific processing/ value-addition. RBI has allowed transformation in such goods subject to the AD bank being satisfied with the documentary evidence and bonafides of the transaction.

3. What are the conditions for MTT

Any goods transferred under MTT should satisfy the following conditions:

• A person is allowed to involve in merchanting trade transactions of such goods which are permitted for exports / imports under the prevailing Foreign Trade Policy (FTP) of India on the date of shipment. 
• Therefore, even though goods are not entering into the domestic territory of India, goods prohibited for import and export shall not be allowed for MTT as well.
• All rules, regulations, and directions applicable to exports (except Export Declaration Form) and imports (except Bill of Entry), are complied with for the export leg and import leg respectively.
• The Authorised Dealer (“AD”) bank shall satisfy himself with the bonafides of the transactions. Further, KYC and AML guidelines should be observed by the AD bank while handling such transactions.
• Both the legs of a merchanting trade transaction are routed through the same AD bank and The bank should verify the documents like invoice, packing list, transport documents and insurance documents. 
• If the original copy of documents is not available then the bank may take Non-negotiable copies duly authenticated by the bank handling documents and satisfy itself about the genuineness of the trade.

4. Is there any time limit for the completion of MTT

• Yes, The RBI has clarified that MTT should be completed within an overall period of 9 months.
• An outlay of foreign exchange shall not go beyond 4 months.
• MTT transaction shall be considered as started when any of the following transactions happens first:
  • date of shipment/export leg receipt or 
  • import leg payment
• Such a transaction is considered completed when any of the above-mentioned activities happen at last.

5. What are the credit Facility and Payment terms for MTT

5.1 Meaning of Technical Terms.

5.1.1 What is the meaning of “Buyer’s Credit”?

• In the case of the purchase of goods from overseas suppliers, sometimes payment for import is financed by the Bank or Financial institution located outside India. Such Financing is called “Buyer’s Credit”.
• However, Foreign Bank or Financial Institution provides credit subject to receipt of a Letter of Comfort (LoC) or Letter of Undertaking (“Lou”) from an Indian Bank.
• “E.g. In the case of MTT, Indian Intermediary Imports goods from outside India. Indian Intermediary may finance such import transactions from a foreign Bank, e.g., the Foreign Branch of its domestic Bank. However, for this purpose, an LoC shall be issued by the Indian Branch to the Foreign Branch.

5.1.2 What is the meaning of “Supplier’s Credit”?

• The suppliers’ credit means credits extended for imports directly by the overseas supplier instead of any bank or financial institution.

5.1.3 What is the meaning of “Letter of Comfort” or “Letter of Undertaking”?

• A letter of Comfort” is a document provided by one bank to another bank assuring the financial soundness of the borrower.
• “Letter of Undertaking” is a contract to perform the promise, or discharge the liability, of a third person in case of his default.
• In case of MTT transaction, when an Indian Intermediary obtains Finance from an overseas Branch then an Indian bank shall provide the LoC or LoU to the foreign bank to confirm financial soundness of the importer.
• LoC is generally issued by the Indian branch of a foreign bank or Financial institution. However, any other bank provides a letter of undertaking.

5.1.4 What is the meaning of “Letter of Credit”?

• A letter of credit is a document issued by a bank that guarantees payment for goods or services when the seller provides acceptable documentation. 
• A letter of credit generally has three participants.
  • First, the beneficiary, the person or company who will be paid, i.e., supplier of goods to Indian Intermediary in case of MTT. 
  • Next, the buyer or applicant of the goods or services, i.e., Indian Intermediary in case of MTT. 
  • Finally, the issuing bank, the institution issuing the letter of credit. 
• Therefore, in the case of MTT, for import leg, a bank shall issue a “Letter of Credit” in favor of a foreign supplier wherein the bank undertakes to make payment to the supplier in accordance with the terms and conditions specified in the letter of credit.
• Similarly, an Indian Intermediary may receive a letter of Credit for an export leg from a foreign customer.
• The facility of discounting of letter of Credit is also available wherein the bank makes payment to the supplier in advance against the letter of credit after deducting its discounting charges. In case of MMT, the Indian Intermediary may get Letter of Credit received from foreign customers discounted to receive payment at earliest.

5.2 Whether any Credit is permitted for the import leg of the transactions?

• As per Guidelines issued by RBI, for the purpose of payment of import leg, the following types of credits are permitted:
  • Short-term credit, either by way of suppliers’ credit or buyers’ credit. Credit shall be granted to the extent MTT transaction is not backed by an advance remittance for the export leg.
  • Discounting the Letter of Credit by the AD Bank. A letter of Credit is received by Indian Intermediary from the foreign customer.
  • However, a Letter of Undertaking (Lou)/ Letter of Comfort (LoC) shall not be issued for supplier’s/ buyer’s credit.

5.3 What is the Manner of payment to the supplier?

• If the Indian Intermediary receives payment against export leg prior to making payment against import leg then such export proceeds shall be parked either in Exchange Earners Foreign Currency (EEFC) account or in an interest-bearing INR account till the import leg liability arises. 
• Such funds shall be strictly used for the payment of the import leg as soon as the liability of the import leg arises without any delay.
• If such receipts are kept in an interest-bearing INR account, hedging thereof may be allowed by the AD bank at the request of its customer, as per extant regulations. No fund/non-fund-based facilities shall be extended against these balances.
• If Indian Intermediary receives payment export leg through discounting of letter of Credit received for export leg LC then such proceeds shall be utilised in the same manner as mentioned above.
• Payment for import leg may also be allowed to be made out of the balances in the EEFC account of the merchant trader.

5.4 What are the implications if Advance payment is to be made for the Import leg?

• Indian Intermediary/Merchant traders may be allowed to make advance payment for the import leg on demand made by the overseas supplier. 
• In cases where sales consideration is not received for the export leg before the outward remittance for the import leg, AD bank may handle such transactions based on its commercial judgment. 
• Further, AD Bank shall ensure that any advance payment for an import leg beyond USD 500,000/- per transaction, shall be made against a Bank Guarantee/ an unconditional, irrevocable standby Letter of Credit from an international bank of repute. 
• Overall prudential limits on allowing such advance payments by a customer may be fixed by the AD bank.

This means, as per the revised guidelines now, merchant traders may participate in advance payment for import leg in case of demand by overseas suppliers. But it is important to ensure here that any such payment beyond the limit of USD 500,000 per transaction, shall be made through an irrevocable standby Letter of Credit from an international bank of repur, against a Bank guarantee/ an unconditional.

5.5 Letter of Credit for import leg against confirmed export order.

• As per para 2 (xii) of the circular, a Letter of Credit to the supplier for the import leg is permitted against the confirmed export order.
• This is to be done keeping in view the foreign exchange outlay of four months and completion of the MTT within nine months. 
• Further, it is permitted only subject to compliance with the instructions issued by the Department of Banking Regulation on “Guarantees and Co-acceptances”, as amended from time to time.

6. Default report by AD Bank to Reserve Bank of India

• AD bank shall ensure one-to-one matching in case of each MTT and report defaults in any leg to the concerned Regional Office of the Reserve Bank, on half yearly basis. The report shall be made within 15 days from the close of each half year, i.e. June and December;
• Merchant traders with an outstanding of 5% or more of their annual export earnings shall be liable for caution listing.
• The merchanting traders shall be genuine traders of goods and not mere financial intermediaries. Confirmed orders must be received by them from overseas buyers. AD banks shall satisfy themselves about the capabilities of the merchanting trader to perform the obligations under the order. The merchanting trade shall result in profit which shall be determined by subtracting import payments and related expenses from export proceeds for the specific MTT.
• AD bank may approach the Regional Office (RO) concerned with the Reserve Bank for regularization of the MTT for deviation, if any, from the prescribed guidelines and the MTT shall be closed only after receiving approval from the RO concerned of the Reserve Bank.

7. Write-off of the unrealized amount of export leg

• AD bank may write-off the unrealized amount of export leg, without any ceiling, on the request made by the Merchanting trader, in the following circumstances:
  • MTT buyer/Foreign Customer has been declared insolvent and a certificate from the official liquidator specifying that there is no possibility of recovery of export proceeds has been produced.
  • The goods exported have been auctioned or destroyed by the Port / Customs / Health authorities in the importing country and a certificate to that effect has been produced.
  • The unrealized amount of the export leg represents the balance due in a case settled through the intervention of the Indian Embassy, Foreign Chamber of Commerce, or similar Organization;

• However, write-off shall be allowed only if MTT is in adherence to all other provisions except the delays in timelines.
• Further, writing off shall be permitted subject to the following conditions:
  • AD bank shall satisfy itself with the bonafides of the transactions and ensure that there are no KYC/AML concerns.
  • The transaction shall not be under investigation under FEMA by any of the investigating agencies/ies.
  • The counterparty to the merchant trader is not from a country or jurisdiction in the updated FATF Public Statement on High Risk & Non-Co-operative Jurisdictions on which FATF has called for counter measures.

8. Agency Commission for MTT

In the case of MTT, an Agency commission is not allowed. However, AD banks may allow payment of agency commission up to a reasonable under exceptional circumstances, subject to the following conditions:

• MTT has been completed in all respects.
• The payment of agency commission shall not result in the MTT ending into a loss.
• The Merchanting trader shall make a specific request to the AD bank in this regard.