FEMA Fundamentals: Current Account, Capital Account & RBI's Role

Key Takeaways

• FEMA (Foreign Exchange Management Act, 1999) replaced FERA in 2000, shifting the regulatory approach from control to management of foreign exchange.
• All foreign exchange transactions are classified as either current account (generally permitted) or capital account (regulated by RBI).
• The RBI is the principal regulator, operating through Authorised Dealers (ADs) -- primarily banks -- for day-to-day forex transactions.
• FEMA applies to the whole of India and also to offices, branches and agencies outside India owned by a person resident in India (Section 1(3)).
• The Act distinguishes between person resident in India and person resident outside India -- residency status determines which regulations apply.

From FERA to FEMA -- The Paradigm Shift

FERA (1973) was a draconian law that treated forex violations as criminal offences with imprisonment. It operated under the presumption that all forex transactions were prohibited unless expressly permitted.

FEMA (1999), effective from 01-06-2000, reversed this approach:

| Feature | FERA | FEMA | |---------|------|------| | Approach | Conservation of forex | Facilitation of trade and payments | | Violations | Criminal offence | Civil offence (penalties, not imprisonment) | | Forex dealings | Prohibited unless permitted | Permitted unless restricted | | Appellate body | Limited | Special Director (Appeals) and Appellate Tribunal | | Scope | Restrictive | Facilitative, aligned with economic liberalisation |

Current Account vs. Capital Account

Current Account Transactions -- Section 2(j)

A current account transaction is any transaction other than a capital account transaction. These include:

• Payments for international trade (import/export of goods and services)
• Remittances for living expenses, education, medical treatment
• Travel-related forex
• Interest payments on loans
• Dividend payments

General rule: Current account transactions are freely permitted unless specifically restricted or prohibited by the Central Government under Section 5. The Foreign Exchange Management (Current Account Transactions) Rules, 2000 list three schedules of restrictions.

Capital Account Transactions -- Section 2(e)

Capital account transactions alter the assets or liabilities (including contingent liabilities) outside India of a person resident in India, or in India of a person resident outside India. These include:

• Foreign Direct Investment (FDI)
• Portfolio investment
• External Commercial Borrowings (ECB)
• Real estate investment
• Overseas Direct Investment (ODI)

General rule: Capital account transactions are regulated by RBI under Section 6. Each type has specific regulations, limits and approval requirements.

RBI and Authorised Dealers

The Reserve Bank of India administers FEMA through:

1. Regulations issued under Section 47 (e.g., FEMA 20, FEMA 3, FEMA 120)
2. Circulars and Master Directions providing operational guidelines to Authorised Dealers
3. Authorised Persons (Section 10) -- primarily AD Category-I banks that handle forex transactions

AD banks are the frontline regulators -- they verify compliance before processing any forex remittance or receipt.

Residency Under FEMA -- Section 2(v)

Person Resident in India includes:

• A person residing in India for more than 182 days during the preceding financial year (with exceptions for going abroad for employment/business or coming to India for employment)
• Any person or body corporate registered or incorporated in India
• An office, branch or agency in India of a person resident outside India

This definition is distinct from Income Tax residency and must be independently assessed for FEMA compliance.

Worked Example -- Classifying a Transaction

Scenario: Mr. Rajesh, a resident Indian, wishes to make the following transactions:

| Transaction | Classification | Rule | |-------------|---------------|------| | Pay USD 50,000 for importing machinery | Current account | Permitted -- trade payment (Section 5) | | Invest USD 1,00,000 in a US company | Capital account | Regulated under ODI rules (FEMA 400) | | Send USD 30,000 for son's university fees | Current account | Permitted under LRS (Schedule III -- no restriction) | | Buy a property in London for GBP 2,00,000 | Capital account | Permitted under LRS within USD 2,50,000 limit | | Receive dividend from US shares | Current account | Freely receivable, report to AD bank |

Each transaction requires different documentation and may have different limits. The AD bank verifies compliance before processing.

Landmark Judgement

Case: Hindustan Machine Tools Ltd. v. Enforcement Directorate Court: Appellate Tribunal for Foreign Exchange (ATFE) Year: 2019 Ruling: The Tribunal held that FEMA being a civil law, the burden of proof on the Department is to establish contravention on a preponderance of probability (not beyond reasonable doubt as under FERA). However, the principles of natural justice must still be followed, and the person must be given adequate opportunity to explain the transaction. Impact: Clarified the evidentiary standard under FEMA proceedings, distinguishing it from the criminal standard that applied under FERA, while affirming due process requirements.

Expert Tip

Always determine FEMA residency status independently from Income Tax residency. A person can be a resident under Income Tax but a non-resident under FEMA (or vice versa). This is particularly critical for NRIs returning to India or Indians going abroad -- the date of return/departure changes FEMA status immediately, while IT status depends on the full financial year. Our qualified CAs ensure clients maintain proper documentation for both regimes.

Section Interconnect

• Next: Chapter 2 -- FDI: Automatic & Approval Route covers how foreign investment flows into India.
• Related: Chapter 3 -- LRS Remittance Scheme details the USD 250,000 annual limit for resident Indians.
• Related: Chapter 4 -- NRI Banking explains how residency status determines NRI account types.

Frequently Asked Questions

Q1: Is FEMA applicable to Indian citizens living abroad? FEMA applicability depends on residency, not citizenship. An Indian citizen living abroad for employment or business who has been outside India for more than 182 days in the preceding financial year is a "person resident outside India" under Section 2(w) and is subject to FEMA regulations applicable to non-residents.

Q2: What is the penalty for FEMA violations? Under Section 13, the penalty can be up to three times the amount involved in the contravention, or Rs. 2 lakh where the amount is not quantifiable. If the contravention continues, an additional penalty of Rs. 5,000 per day may apply. FEMA violations are civil offences, not criminal.

Q3: Can current account transactions be restricted? Yes. While generally permitted, the Central Government can impose restrictions under Section 5 read with the Current Account Transaction Rules. Schedule I lists prohibited transactions (e.g., lottery remittances, margin trading), Schedule II lists transactions requiring Government approval, and Schedule III lists transactions requiring RBI approval.

---

Disclaimer: This article is for educational purposes only and does not constitute legal or professional advice. FEMA regulations are subject to frequent changes through RBI circulars and Government notifications. Readers should consult qualified CAs or FEMA professionals before acting on any information provided here.