The Foreign Exchange Management Bill, 1998
Salient Features

Porus F Kaka

In the monsoon session of Parliament, the Foreign Exchange Management Bill, 1998 ("FEMA") was introduced and this Article proposes to examine its salient features.

While FEMA has been lauded unlike the Money-Laundering Bill, 1998, from a perusal hereafter, it will become undoubtedly clear that what is proposed to be given away or liberalized, is given with one hand and taken away by the other hand or alternatively given by way of a clenched fist. Though undoubtedly the most significant beneficial provision is the removal of the power to arrest presently available with the Enforcement Directorate.


The Preamble of FEMA states the objective of the Bill to facilitate external trade and payments for promoting the orderly development and maintenance of foreign exchange market in India. Contrasted with the preamble to FERA which was to amend the law regulating payments and dealings in foreign exchange and securities. The preamble thus undoubtedly denotes the objective of more liberal foreign exchange regime and would be useful when interpreting the enactment.

Unlike FERA which also had been specifically applied to citizens of India, outside India FEMA does not do the same. However, section 1(3) of FEMA provides that, it will apply to branches, offices and agencies outside India which are owned or controlled by a person resident in India. What is meant by owned or controlled and the extent thereof will be undoubtedly an issue in the coming years. For example could a non-resident sole selling agent situated outside India, whose business is contractually subjected to extensive controls by his Indian principal become subject to FEMA for his international business?


The important definitions are:

  1. Section 2(c) which deals with "authorized person" and for the first time includes "off-shore banking unit" so as to give us an indication that a Central Government perhaps intends to create such entities in the future.
  2. Section 2(e) "capital account transaction" which is defined to mean a transaction which :
    1. alters assets or liabilities including contingent liabilities outside India of persons resident in India; or
    2. alters assets or liabilities in India of persons resident outside India; and
    3. includes transactions set out in sub section 6(3) such as:
      1. transfer or issue of any foreign security by a person resident in India;
      2. transfer or issue of any security by a person resident outside India;
      3. transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India;
      4. any borrowing or lending in foreign exchange in whatever form or by whatever name called ;
      5. any borrowing or lending in rupees in whatever form or by whatever name called between a person resident in India and a person resident outside India;
      6. deposits between persons resident in India and persons resident outside India;
      7. export, import or holding of currency or currency notes;
      8. transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India;
      9. acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India;
      10. giving a guarantee or surety in respect of any debt, obligation or other liability incurred,--
        1. by a person resident in India and owed to a person resident outside India, or
        2. by a person resident outside India.

      This definition is very important as transactions other than capital account transactions are proposed to be freed by FEMA which defines current account transactions as:

      "Current account transaction" means transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes,--

      1. payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business,
      2. payments due as interest on loans and as net income from investments,
      3. remittances for living expenses of parents, spouse and children residing abroad, and
      4. expenses in connection with foreign travel, education and medical care of parents, spouse and children;

      The issues that arise with these two definitions are:

      • it must be remembered that even a revenue transaction such as a sale of goods or billing for services alters ones assets or liabilities at the end of the day;
      • however, since it is specifically included as a current account transaction, the way to interpret section 2(e) would be that the transaction considered by itself should alters assets but not a transaction whose effect alters assets or liabilities.
      • Persons resident in India going abroad may be able to obtain short term banking and credit facilities provided they are in the ordinary course of business.
      • Income from investments is now on current account but has been prefixed by the word "net". Therefore, will it mean that a foreign investor will only be entitled to remit income from his investments of the "net" amount only. If "net" is supposed to mean also after tax, it could create certain difficulties when contractually tax is born by a person other than the investor concerned.
      • With the abolition of Gift Tax Act, the proviso by permitting remittances for living expenses, education and medical expenses of parents, spouse and children as a current account transaction will be extremely welcome. However, the remittances for living expenses in India is not covered.
      • The definition of "export" has now been widened to include provision of services from India to a person outside India.
      • The definition of "foreign security" had been enlarged to include securities expressed in foreign currency but where remittances or returns such as interest or dividend are payable in Indian currency. This perhaps ropes in the Global Depository Receipts issued by Indian companies and other external borrowings where interest is payable in rupees.
  3. The entire concept of "resident in India" is proposed to be dramatically changed from what it used to be the provisions of FERA. Under FEMA the determination of the ‘intention’ of the person has been changed to an arithmetical calculation.
    • "Person resident in India" has been defined to mean:
      1. a person residing in India for more than one hundred and eighty-two days during the course of a period of three hundred and sixty-five days immediately preceding the date on which such period is reckoned,
      2. any person or body corporate registered or incorporated in India,
      3. an office, branch or agency in India owned or controlled by a person resident outside India;
      4. an office, branch or agency outside India owned or controlled by a person resident in India;
  4. The definition now proceeds similar to the lines of the Income-tax Act. However, unlike under Income tax a person may become resident in India even when a person comes on a tour or on holiday under FEMA it is not free from doubt whether he could be said to be "residing" in India when he lives in a hotel on holiday. In the opinion of the author, the act of "residing" requires something more than mere physical presence otherwise the section could simply have stated as including a ‘person in India’ as opposed to ‘residing in India.’
  5. The concept of a person resident in India has also been extended to offices branches or agencies in India owned or controlled by non residents. Thus this brings in the restrictions applicable to non-residents having places of business in India under the old FERA by making them persons resident in India and subject to the restrictions of FEMA. Thus an interesting situation will arise where a body corporate having a branch in India will be simultaneously resident for the branch and non resident in respect of its head office. It will therefore have to simultaneously view transactions from its head office and between its branch from two different heads. Also once the branch is resident in India if it remits profit would that be exempted from FERA as a current account transaction as a net income from investments or whether it would-be viewed as an alteration of assets of a person resident in India and thereby being a capital account transaction.
  6. A new definition "repatriate to India" has been included to mean bringing into India the realized foreign exchange and selling to an authorized person, or holding in India with an authorized person the extent permitted by the Reserve Bank. Also included is the use of a realized amount for discharge of a debt or liability denominated in foreign exchange.
  7. A new definition of "service" has-been included but strangely it is defined as service made available to potential users. Why the word ‘potential’ ignoring the word ‘actual’ has been made is peculiar.
  8. Also service has been defined to include provisions of facility in connection with several activities such as banking, financing, insurance, medical assistance real estate, etc., but not rendering of service free of charge or under a contract of personal service.
    The definition of "transfer" has been extended to include:

    "transfer" includes sale, purchase, exchange, mortgage, pledge, gift, loan or any other form of transfer of right, title possession or lien.

Regulation and Management of Foreign Exchange

Section 3 prohibits a person from dealing or transferring any foreign exchange or foreign security other than an authorized person. This prohibition would obviously apply to all persons situated within India whether resident or non resident but since the Act is defined to extend to persons, branches, offices and agencies controlled, or owned by persons outside India, it could create difficulties if the transaction is not a current account transaction as what is meant by controlled as set out earlier in this article is not clear.

Section 4 prohibits persons resident in India from acquiring, holding, owning, possessing or transferring:

  • any foreign exchange
  • any foreign security
  • any immovable property situated outside India unless otherwise permitted by theAct.

Section 5 however permits all persons to sell or draw foreign exchange from authorized persons provided such sale or drawal is on current account. This section seems to be the primary motivation behind FERA to free current account transactions. Having said this it is whittled down by the following:

  • The proviso to section 5 gives the Central Government powers to impose restrictions on current account transactions;
  • Under section 40, the section itself can be suspended by the Central Government from operation if it is in the public interest;
  • Under section 41 the Central Government may give directions to the Reserve Bank as it thinks fit;
  • As a matter of ultimate precaution the bureaucracy has introduced section 46(2)(a) which again gives the Central Government powers to make rules that imposes reasonable restrictions on current account transactions.

Therefore, what is permitted by section 5 has been retained in the hands of the bureaucracy several times over in FEMA.

  • Also section 49(3)(b) provides for all circulars issued originally under FERA which are deemed to continue under FEMA.

In effect more or less nothing cannot be done by the Central Government under FEMA which it could do under FERA on current account transactions, though its powers are limited by the concept of "reasonable restrictions."

Similarly, section 6 permits persons to sell or draw foreign exchange for capital account transactions. Section 6(2), however, provides that the Reserve Bank may specify the class or classes of capital account transactions which are permissible and the limits for which foreign exchange can be obtained for those foreign exchange transactions. However, the proviso to sub-section prohibits the Reserve Bank from:

  • imposing any restriction for the drawal of foreign exchange for payments due on account of amortization of loans; or
  • for depreciation of direct investments in the ordinary course of business.

    Therefore, by the first part the Reserve Bank cannot impose restrictions on loans already obtained though it is not clear what the latter part seeks to prohibit unless it permits persons already entitled to invest under existing permissions of obtaining further foreign exchange to replenish such investments.

Reserve Bank has reserved to itself several other powers which have been set out earlier in dealing with the definition of capital account transactions under section 6(3). It must be noted that though alteration of contingent liability in India of persons resident outside India is not a part of the definition of capital account transaction under the first part of Section 2(e) still under 6(3)(j) the giving of guaranty or surety by persons resident outside India is roped in.

Sub-sections 6(4) and (5) provide the necessary permission for persons resident in India to hold, own and transfer or invest their foreign property acquired when they were resident outside India or Indian property acquired when they were resident in India or inherited respectively.

Section 6(6) of FEMA harks back to section 29 of FERA and permits the Reserve Bank to regulate, prohibit, etc., establishments in India of branches offices or persons resident outside India.

Sections 7 & 8 are drawn from the provisions of section 8 & 18 of FERA and require exporters to repatriate foreign exchange to India within times specified subject to the permissions granted by the Reserve Bank upto the limits specified. Such limits and permissions can be notified under section 9.

Interestingly, under section 9(e) foreign exchange acquired by legitimate means is permitted to be released from the prohibitions from holding and repatriation to India, upto such limits as the Reserve Bank may specify from the provisions of sections 4 & 8.

The author wonders why was there a need for the inclusion of the word "legitimate" as one normally assume that the permission granted by the Reserve Bank applys only to legitimate means of acquisition of foreign exchange as the provisions of Section 4 and 8 only apply to ‘persons resident in India’ and not illegitimate transactions but perhaps the inclusion of the word "legitimate" is a poor reflection of the times that we are in.

Authorized Person

Chapter III and sections 10 to 12 deal with the guidelines, powers to issue directions to inspect etc., available with the Reserve Bank against authorised persons.

Penalties and Prosecutions

For contravention of the provisions of the Act, rules, notifications, directions or orders under the Act, or conditions subject to which an authorisation is issued by the Reserve Bank a person can liable upto a penalty to twice the sum involved. Where the amount is not quantifiable one lakh rupees and if the contravention is a continuing one for an additional rupees five thousand per day under Section 13.

The only power for arrest and civil imprisonment now under FEMA is for failure to make payment of the penalty imposed under section 13. The penalties are leviable by the adjudicating authorities as appointed under section 16. Where a person fails to make the payment of penalty imposed under section 13 within a period of 90 days he may render himself liable to civil imprisonment. The adjudicating authority has to issue and serve a notice asking the defaulter to show cause why he should not be committed to the civil prison and no order for arrest or detention can be made unless the adjudicating authority or reasons in writing is satisfied that the defaulter has with the object or effect of obstructing the recovery of penalty after issue of notice by the adjudicating authority dishonestly transferred, sold or removed any part of his property or having the means to pay the arrears or substantial part thereof refuses or neglects to pay the same.

There is a power of arrest to issue a warrant for arrest without complying with the above, if the adjudicating authority is satisfied by Affidavit that with the object or effect of delaying the execution of the certificate the defaulter is likely to abscond or leave the local limits of the jurisdiction of the adjudicating authority. If a person fails to make appearance against a notice issued and served as set out above, the adjudicating authority can issue a warrant for arrest. However, if the defaulter pays the amount enters in the warrant of arrest as due and the costs of the arrest to the officer arresting him the officer is required to release him at once. There are further provisions dealing with the procedure to detain defaulter pending the conclusion of the enquiry set out above. Persons can be detained in a civil prison in execution of certificate if it is an amount exceeding rupees one crore for periods upto 3 years and in any other case upto 6 months. However, such person can be immediately released from detention if the amount mentioned in the warrant for his detention being paid to the officer in charge of the civil prison. However, payment of the amount mentioned in the warrant will not release the person from liability for the arrears. The Director of Enforcement has been given the powers to compound the contravention made by persons of the provisions of the Act, rules, notifications, directions, orders, etc.

Adjudication and Appeal

The procedure for adjudication and appeal is set out in Chapter V sections 16 to 34.

The Central Government has the power to appoint adjudicating authorities who can levy the penalty under section 13. The adjudicating authority is required to hold an enquiry and also give the accused person a reasonable opportunity of being heard before imposing any penalty. However, the adjudicating authority can direct a person to furnish a bond or guarantee if it is of the opinion that the person is likely to abscond or evade the payment of penalty.

Against the order of the adjudicating authority an appeal will lie to the Appellate Tribunal and has to be filed within 45 days from the date of receipt of the order by the adjudicating authority accompanied by the prescribed fee and in the prescribed form. There is a further power vested in the Appellate Tribunal to condone appeals filed after 45 days if sufficient cause is shown.

While filing the Appeal the person appealing is required to deposit the amount of penalty with an authority to be notified by the Central Government. However, the Tribunal has the power to dispense with such deposit subject to conditions it sees fit to impose to safeguard the realization of penalty. It is interesting that in the legislation itself Tribunal powers to dispense with the deposit are hedged in by a requirement that it should safeguard the realization of penalty. Therefore unless security is provided the Tribunal may not be in a position to effectively exercise its powers in cases of tremendous financial hardship.

The power of the Tribunal is to pass "such orders as it thinks fit confirming modifying or setting aside the order appealed against." It may be noted at this stage also that further powers are set out in section 27 which provide that the Tribunal will not be bound by the procedure laid down by the Code of Civil Procedure 1908 but shall be guided by the principles of natural justice. The principles of natural justice now perhaps elevated to a status of a fundamental right under Article 14 of the Constituition are now legislatively part of a proposed enactment. The Tribunal has also the power vested in a Civil Court to review its decision which power on the basis of the decision of the High Court are not available to the Income-tax Appellate Tribunal.

Appeals will lie from the decision or order of the Tribunal to the High Court within the jurisdiction of whom the aggrieved party ordinarily resides or carries on business or personally works for gain is situated. Appeals will lie only on questions of law and are required to be filed as an Appeal in the High Court within 60 days from the date of communication of the Order. Where the decision of the Tribunal is against the Central Government, it can file an Appeal in the High Court within the jurisdiction of which the Respondent or where there are more than one Respondent any one of them ordinarily resides or carries on business or personally works for gain.

Directorate of Enforcement

Under section 36 powers of the Directorate of Enforcement of Officers of Enforcement are equated with the powers under Chapter XIII of the Income-tax Act. Though in the marginal note in the column it is mentioned as a power to arrest, there is no power under Chapter XIII of the Income-tax Act to arrest any person. The powers under Chapter XIII relates to discovery, inspection, enforcement, appointing, examining under oath, search and seizure, etc.

There is a presumption that documents obtained and signatures in writing therein are of the person executing the same unless the contrary is proved.

Powers Retained Under FEMA

  • The first major power and most sweeping is the power retained by the Central Government under section 40 to suspend, relax, indefinitely the operation of all or any of the provisions of the Act.
  • The proviso to section 5 gives the Central Government powers to impose restrictions on current account transactions;
  • Under section 46, the Central Government has retained the power to make rules to impose reasonable restrictions on current account transactions.
  • Similarly, under section 47 Reserve Bank has retained the power to make regulations to regulate capital account transactions.

Therefore, the Central Government and or Reserve Bank and or the bureaucracy have retained several powers available under FERA which by legislation they appear to permit under FEMA.

It is interesting that the fear of the bureaucracy to give something away is so great that they have retained the right to regulate the same, several times under the same enactment.

Also it is important not to overlook section 49(3)(b) which provides as under:

"anything done or any action taken or purported to have been done or taken including any rule, notification, inspection, order or notice made or issued or any appointment, confirmation or declaration made or any license, permission, authorization or exemption granted or any document or instrument executed or any direction given under the Act hereby repealed shall, in so far as it is not inconsistent with the provisions of this Act, be deemed to have been done or taken under the corresponding provisions of this Act"

This provision seems to revive and continue all the original circulars but interesting complications will arise since the entire thrust of FEMA first grants permission and thereafter grants powers to regulate such permission whereas FERA prohibited all transactions except those permitted. Therefore, unless the old circulars are simultaneously read as not merely "permitting or enabling circulars" but also simultaneously as "prohibiting circulars" in respect of transactions other than those permitted several interesting situations and complications would arise.


  • In the preamble the bill starts by saying "be enacted by parliament in the forty-ninth Year of the Republic of India." The forty-ninth year went in 1996-97 and since this was probably in the original bill, it shows how many years this bill has been in formation.
  • In sections 5 and 6 there is a new word added to the English language namely "drawal."

Porus F. Kaka

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