FEMA & Cross-Border

FEMA — the Foreign Exchange Management Act, 1999 — is one of those statutes that most businesses assume does not apply to them, until the day they discover it does. Cross-border payments, inbound investment, overseas structures, foreign currency loans: each of these carries a regulatory dimension that is easy to overlook and difficult to unwind once the non-compliance has accumulated. The Enforcement Directorate has only grown more active over the last several years. Getting the FEMA framework right — at the outset, not in retrospect — is both a legal and a business necessity.

FEMA and the Foreign Exchange Regime

FEMA replaced the Foreign Exchange Regulation Act, 1973 (FERA) with a deliberate change of philosophy. FERA treated foreign exchange violations as criminal offences — the burden was on the accused to prove innocence, and imprisonment was a real consequence even for technical infractions. FEMA shifted the default to a civil enforcement model: contraventions attract penalties and compounding, not prosecution, unless the violation rises to the level of a scheduled offence under the Prevention of Money Laundering Act (PMLA).

The primary regulator under FEMA is the Reserve Bank of India. The RBI issues rules and regulations — the FEMA Non-Debt Instruments Rules (NDI Rules, formerly FEMA 20 and related regulations), the Overseas Investment Rules and Regulations (OI Rules, notified in 2022), the FEMA Compounding Rules, the ECB framework, and sector-specific directions — that govern virtually every category of cross-border transaction. The Enforcement Directorate is the enforcement arm: it investigates violations, issues summons, attaches assets, and adjudicates penalties.

Current Account vs Capital Account

The FEMA framework draws a fundamental distinction between current account and capital account transactions. Current account transactions — trade payments, remittances for services, travel, education, family maintenance — are generally permissible subject to the Liberalised Remittance Scheme (LRS) limit (currently USD 250,000 per financial year per resident individual) and the rules under Schedule I, II, and III of the FEMA Current Account Transactions Rules. Capital account transactions — equity investments, external commercial borrowings, acquisition of immovable property abroad — are permissible only to the extent specifically allowed by the RBI.

This distinction matters in practice: a payment that is treated as a current account transaction and processed through the banking channel without prior RBI approval may turn out, on examination, to be a capital account transaction that required a specific approval or reporting. The consequences are not trivial.

Inbound FDI: Structuring and Compliance

Foreign Direct Investment into India flows through two routes: the automatic route and the government route. Under the automatic route, a foreign investor can invest in an Indian company without prior approval from the RBI or the Government — the investment is simply made, and the reporting obligations follow. Under the government route, prior approval from the relevant ministry or the Foreign Investment Facilitation Portal is required before the investment is made.

Most sectors are under the automatic route now, but the conditionalities attached to the automatic route are often as consequential as the route itself. Sectoral caps (49% in insurance, 74% in telecom, 100% in most manufacturing), entry conditions (minimum capitalisation norms for NBFC-type entities, licensing requirements for certain sectors), and sector-specific restrictions (prohibitions in gambling, real estate, multi-brand retail subject to conditions) all have to be mapped at the structuring stage — not discovered after the investment has closed.

Pricing and Valuation

One of the most practically important constraints under the NDI Rules is the pricing guideline. For unlisted Indian companies, a foreign investor cannot pay less than the fair market value of the shares determined under a prescribed methodology (discounted cash flow or net asset value, by a SEBI-registered merchant banker or chartered accountant). For listed companies, the price cannot be lower than SEBI-prescribed thresholds. This means a foreign investor cannot get a bargain price on Indian equity — the pricing must be documented, defensible, and arm's-length.

The same pricing discipline applies on exit: a resident cannot pay more than the fair market value when buying back shares from a non-resident. The RBI has been consistent in enforcing this, and compounding applications that arise from pricing violations tend to attract higher compounding amounts precisely because the violation has a direct financial dimension.

Reporting Obligations: FC-GPR and FC-TRS

Every issuance of equity instruments to a non-resident triggers a Form FC-GPR filing with the RBI through the FIRMS portal, to be made within 30 days of the issuance. Every transfer of shares between a resident and a non-resident (in either direction) triggers a Form FC-TRS, to be filed within 60 days. These timelines are strict, and late filings are a compounding trigger. Many businesses that have had foreign investment for years discover — during a fundraise or an M&A due diligence — that they have missing or late FC-GPR or FC-TRS filings going back several years.

Downstream Investment

When an Indian company that is itself foreign-owned (or foreign-controlled) makes an investment in another Indian company, the rules on downstream investment apply. The downstream investment is treated as indirect foreign investment, and the FDI restrictions applicable to the investee company's sector apply — the foreign investor cannot circumvent sectoral caps by routing through an Indian holding company. Downstream investments must be reported through Form DI within 30 days.

Outbound Investment (ODI)

The Overseas Investment framework was substantially liberalised and restructured in 2022, with new rules and regulations replacing the earlier FEMA 120 regime. The new framework — the Foreign Exchange Management (Overseas Investment) Rules 2022 and companion regulations and directions — distinguishes between Overseas Direct Investment (ODI) and Overseas Portfolio Investment (OPI), and has introduced a cleaner structure for what was previously a patchwork of circulars and FAQs.

An eligible Indian party — broadly, a company or LLP incorporated in India, or a resident individual — can make an ODI in a foreign entity through the automatic route up to 400% of its net worth (for corporate entities) or within the LRS limit (for individuals). The investment can be in equity, compulsorily convertible instruments, or through a step-down subsidiary structure. A number of prohibited structures continue, however: investment in entities engaged in real estate (other than through a listed entity) or financial services activities by non-regulated entities requires specific approval; investment in foreign entities with interests in India (round-tripping concerns) is scrutinised carefully.

Reporting Under the New Framework

The reporting obligations under the ODI framework are more granular than before. Form ODI must be filed for each investment through the authorised dealer bank. Annual Performance Reports (APRs) are required for each foreign entity in which an ODI has been made, to be filed by the end of December each year. Disinvestment, dissolution, or structural changes in the foreign entity also trigger reporting. These obligations apply going forward and — through the concept of ratification and regularisation — also have implications for pre-2022 overseas structures.

Common Compliance Gaps

Outbound investment compliance is an area where gaps tend to accumulate quietly. Businesses that set up foreign subsidiaries several years ago may not have filed consistent APRs, may not have reported step-down acquisitions by those subsidiaries, or may have set up offshore holding structures that did not go through the correct RBI process. Each of these gaps is potentially a FEMA contravention, and the compounding exposure grows with the passage of time.

Compounding of FEMA Contraventions

Compounding is the mechanism by which FEMA contraventions are settled. An applicant voluntarily approaches the RBI (or the ED, for certain categories of contraventions) and admits the violation; the authority levies a compounding amount; upon payment, the contravention is treated as settled and no further action is taken. Compounding is available for most FEMA violations and is generally the appropriate remedy for contraventions that arise from oversight, delay, or procedural gaps rather than deliberate evasion.

The RBI processes compounding applications through its regional offices. The compounding amount is assessed under a formula set out in the Compounding Rules — a combination of the amount involved in the contravention, the duration of the violation, and whether it is a first or repeat contravention. The formula provides a floor and a ceiling, and the actual amount is determined by the compounding authority within that range after considering aggravating and mitigating factors.

Preparing a Compounding Application

A well-prepared compounding application is more than a form submission. It requires a clear statement of facts (including the precise nature and timeline of the contravention), supporting documents for each transaction involved, evidence of subsequent regularisation where possible, and a computation of the compounding amount under the applicable formula. The application should also address why the contravention occurred and what steps have been taken to prevent recurrence. Poorly prepared applications result in queries, delays, and — in some cases — higher compounding amounts because the applicant has failed to demonstrate that the matter is fully understood and remedied.

Factors That Affect the Compounding Amount

• The total amount involved across all contraventions in the application
• The period for which the contravention subsisted (longer duration = higher amount)
• Whether the applicant is a repeat compounder or has prior FEMA violations on record
• Whether the violation has a financial benefit dimension (e.g., pricing below FMV)
• The degree of voluntary disclosure and cooperation with the compounding authority
• Evidence of subsequent compliance — filing of delayed reports, repatriation of funds, etc.

When Compounding Is Not Available

Compounding is not available where: the contravention involves a transaction that is not permissible under FEMA even with prior approval (i.e., an absolute prohibition rather than a procedural failure); where the matter is pending before the Enforcement Directorate or the Appellate Tribunal in enforcement proceedings; or where the applicant is under investigation for PMLA offences related to the same transactions. In these situations, the matter has to be addressed through the enforcement and adjudication route, not the compounding route.

Enforcement Directorate Proceedings

The Enforcement Directorate operates under two distinct statutory frameworks, and conflating them is a mistake that can have serious consequences. Under FEMA, the ED exercises civil enforcement jurisdiction: it investigates FEMA contraventions, issues show cause notices, and adjudicates penalties. The maximum penalty under FEMA civil proceedings is three times the amount involved in the contravention, or two lakh rupees where the amount cannot be quantified. This is civil liability — it does not carry criminal exposure in itself.

Under the Prevention of Money Laundering Act (PMLA), the ED exercises criminal enforcement jurisdiction. FEMA violations become relevant under PMLA when the proceeds of the foreign exchange contravention constitute "proceeds of crime" — a predicate offence for money laundering. When a FEMA contravention is alleged to be connected to a scheduled offence under the PMLA (and FEMA violations are now listed as scheduled offences under the Schedule to the PMLA), the ED can initiate attachment proceedings, arrest, and prosecution under the PMLA. This is an entirely different — and much more serious — category of proceedings.

The Mechanics of ED Proceedings Under FEMA

ED proceedings under FEMA typically begin with summons under Section 37 of FEMA, requiring the person to produce documents and/or appear for statement recording. Statements recorded under FEMA are admissible in adjudication proceedings. The ED can then issue a show cause notice setting out the alleged contraventions and the proposed penalty. After giving an opportunity of hearing, the adjudicating authority (the ED) passes an order imposing or declining to impose a penalty.

Appeals from the ED's adjudication orders lie to the FEMA Appellate Tribunal (the Appellate Tribunal for Foreign Exchange, ATFE), and from there to the relevant High Court on questions of law. The appellate timeline is significant — ATFE matters can take two to three years — and the strategic choice between contesting through the appellate route versus attempting compounding (where available) has to be made carefully at the outset.

Why Early Intervention Matters

The single most important thing to understand about ED proceedings is that early legal intervention — ideally before or at the summons stage — can materially change the trajectory of the matter. Statements recorded before legal counsel has reviewed the relevant documents and transactions, or documents produced without understanding their implications, can create difficulties that are hard to walk back. The ED is sophisticated about how FEMA violations often shade into PMLA territory, and a matter that begins as a civil FEMA inquiry can escalate if the initial engagement is not handled carefully.

Cross-Border Structures and Transactions

External Commercial Borrowings (ECB)

External Commercial Borrowings are foreign currency loans raised by eligible Indian borrowers from recognised foreign lenders. The RBI's ECB framework — now consolidated in the Master Direction on ECB — specifies the eligible borrower categories (companies, LLPs, NBFC-MFIs, etc.), the eligible lenders (foreign equity holders, multilateral/bilateral finance institutions, overseas branches of Indian banks, etc.), minimum average maturities by track and loan size, and end-use restrictions.

End-use restrictions are the most commonly misunderstood aspect of the ECB framework. ECB proceeds cannot be used for real estate, capital market investment, equity investment in India, working capital for most categories, or repayment of rupee loans (with exceptions under specific tracks). The permitted end-uses differ between Track I (foreign currency ECB) and Track III (rupee-denominated ECB). A company that raises an ECB and uses the proceeds for a restricted purpose has a FEMA contravention on its hands, and the compounding exposure is typically measured against the full ECB amount.

Compulsorily Convertible Instruments in FDI

Compulsorily Convertible Debentures (CCDs) and Compulsorily Convertible Preference Shares (CCPS) occupy an important place in Indian FDI structuring. They are treated as equity under the NDI Rules — not as debt — which means they count toward the foreign equity stake in the company and are subject to FDI caps and pricing guidelines. This distinction matters: plain vanilla debentures or preference shares that are optionally convertible or redeemable at the option of the holder are treated as debt, not equity, and fall under the ECB framework rather than the FDI framework. Getting this classification wrong has downstream consequences for reporting, pricing, and sectoral cap compliance.

Branch and Liaison Offices

Foreign companies that want a presence in India without incorporating a subsidiary can set up a branch office or liaison office under the FEMA (Establishment in India of a Branch Office or a Liaison Office or a Project Office or any other place of business) Regulations. Branch offices can carry out a limited set of activities; liaison offices are more restricted (they cannot earn income in India). Both require prior RBI approval (through the AD bank) and annual compliance filings including an Annual Activity Certificate from a CA. The distinction between permitted and impermissible activities is enforced, and branch offices that creep beyond their permitted scope create FEMA exposure.

GIFT City Structures

The Gujarat International Finance Tec-City (GIFT City) International Financial Services Centre (IFSC) operates under a distinct regulatory framework — the International Financial Services Centres Authority (IFSCA) Act 2019 and the regulations issued thereunder. Entities established in the GIFT IFSC are treated as non-residents for FEMA purposes, which creates significant flexibility for cross-border structures: an Indian group can set up an IFSC entity to raise foreign capital, issue foreign currency instruments, or run treasury and fund management operations, with a regulatory perimeter that is more permissive than the onshore FEMA framework. IFSCA has been actively expanding the product suite available in the IFSC, and the GIFT City route is increasingly relevant for fund structuring, aircraft leasing, insurance, and fintech operations.

Round-Tripping Concerns

The RBI and ED are alert to round-tripping structures — arrangements where Indian funds leave the country, are routed through foreign entities, and return as FDI into India, giving the appearance of foreign investment without the substance. Round-tripping is not a separately defined violation under FEMA, but such structures typically involve multiple FEMA contraventions (improper outbound investment, fictitious inward remittance) and are also likely to attract PMLA scrutiny. When structuring any outbound investment that has a component of reinvestment into India, the round-tripping concern must be addressed at the design stage.

How We Work on FEMA Matters

FEMA practice at Tejas Advisors spans the full spectrum — from structuring new cross-border investments to remedying legacy compliance gaps to representing clients before the RBI and the Enforcement Directorate. We work with founders, in-house teams, and investors, and we are used to engaging at the technical level that FEMA matters require.

• Inbound FDI structuring — route analysis, sectoral cap mapping, pricing documentation, and FC-GPR/FC-TRS filing oversight
• Outbound ODI structuring — automatic route eligibility, Form ODI, APR compliance, and offshore structure review
• ECB advisory — eligible borrower and lender confirmation, end-use compliance, and drawdown documentation
• Compounding applications — preparation, filing, and representation before the RBI compounding authority
• Legacy compliance audits — identification and quantification of historic FEMA gaps in advance of fundraising or M&A
• ED summons response and representation — document review, statement preparation, and adjudication proceedings
• FEMA Appellate Tribunal representation — filing and arguing appeals against ED adjudication orders
• GIFT City and IFSC structuring — entity setup, IFSCA regulatory guidance, and FEMA interface analysis
• Branch, liaison, and project office regulatory compliance

FEMA is a technical area where the cost of getting it wrong — in time, money, and management bandwidth spent managing enforcement — almost always exceeds the cost of getting it right the first time. If you have a cross-border structure that has not been reviewed recently, or an active FEMA or ED matter that needs attention, we are available to engage directly.