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The Foreign Exchange Management Act, 1999 regulates foreign exchange and cross-border payments in India. Its objective is to facilitate external trade and payments and promote the orderly development and maintenance of the foreign-exchange market in India. FEMA came into force on 1 June 2000.
FEMA residential status determines exchange-control permissions. Income-tax residential status determines the scope of taxable income. The two tests are independent and can produce different results for the same person.
Current-account and capital-account transactions
| Category | Meaning | Common examples |
|---|---|---|
| Current-account transaction | A transaction other than a capital-account transaction, including specified payments connected with foreign trade, services, interest, living expenses and travel. | Imports, travel, education, medical treatment, maintenance of relatives, interest and ordinary service payments. |
| Capital-account transaction | A transaction that alters assets or liabilities, including contingent liabilities, outside India of a person resident in India or in India of a person resident outside India. | Overseas investment, acquisition of immovable property, borrowing or lending, guarantees, deposits and investment in Indian securities by non-residents. |
How the permission framework differs
Under section 5, a person may generally buy or draw foreign exchange from an authorised person for a current-account transaction, subject to restrictions prescribed by the Central Government. The Foreign Exchange Management (Current Account Transactions) Rules, 2000 list prohibited transactions and transactions requiring approval or compliance with prescribed conditions.
Under section 6, capital-account transactions are permitted only within the classes, limits and conditions specified under FEMA and the relevant regulations or rules. The applicable framework differs for residents, non-residents, individuals, companies, lenders, borrowers and investors.
Foreign exchange should be bought, sold or transferred only through an authorised person and for a permitted purpose. A bank processing a remittance does not remove the customer’s responsibility to provide accurate purpose and supporting information.
Person resident in India under FEMA
FEMA uses a residence test based on physical presence for more than 182 days during the preceding financial year, together with important purpose-based exclusions and inclusions. A person leaving India for employment, business or another purpose indicating an uncertain period of stay abroad may become non-resident under FEMA. A person coming to India for such purposes may become resident under FEMA.
Because intention and purpose are relevant, nationality, passport, citizenship, OCI status or a simple day count alone may not determine FEMA residence.
FEMA residence versus income-tax residence
| Issue | FEMA | Income-tax law |
|---|---|---|
| Primary purpose | Exchange-control permissions and cross-border asset/liability rules | Determines the scope and rate of taxation |
| Core test | Presence plus purpose and intention of stay or departure | Statutory day-count and taxpayer-specific conditions |
| Period considered | Generally preceding financial year with purpose-based rules | Relevant previous year or tax year under the applicable Act |
| Possible outcome | A person may be non-resident under FEMA | The same person may still be resident or non-resident under income-tax law based on separate tests |
Practical compliance checklist
- Classify the transaction as current account or capital account.
- Determine FEMA residential status on the transaction date.
- Identify the applicable rule, regulation, limit, approval or reporting requirement.
- Use an authorised dealer or other authorised person.
- Provide the correct purpose code and truthful declarations.
- Retain bank advice, contracts, invoices, investment records and regulatory filings.
- Separately analyse income-tax, TDS, GST and disclosure consequences.
Examples
- Foreign university fee: generally, a current-account remittance, subject to the applicable remittance framework and documentation.
- Purchase of shares of a foreign company: a capital-account transaction governed by overseas-investment rules.
- NRI purchase of Indian securities: a capital-account transaction governed by the relevant non-debt or debt-instrument framework and investment route.
- Foreign-currency loan: a capital-account transaction requiring compliance with the applicable borrowing or lending regulations.
Common mistakes
- Using income-tax residence to decide FEMA permissions.
- Assuming every current-account transaction is unrestricted.
- Treating a bank’s processing as regulatory approval.
- Sending money through an unauthorised channel.
- Ignoring post-transaction reporting for investments, loans or guarantees.
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