FERA treated foreign exchange as a crime problem. FEMA treats it as a management problem. That single shift, from prosecution to regulation, explains almost every rule that follows.
Current account transactions are free unless restricted; capital account transactions are prohibited unless permitted. Everything in FEMA turns on which side of that line your transaction falls.
The Foreign Exchange Management Act, 1999 replaced the Foreign Exchange Regulation Act, 1973 on 1 June 2000, and the change was philosophical rather than cosmetic. Under FERA, dealing in foreign exchange without permission was a criminal offence with the burden of proof on the accused. Under FEMA, contraventions are civil, penalties are monetary, and most breaches can be compounded — paid off and closed — with no criminal record.
For a founder raising from a Singapore fund, an exporter billing in dollars, or an NRI buying a flat in Pune, FEMA is the operating system underneath the transaction. Classify it wrongly and the money may be legally unremittable, and no amount of commercial logic fixes that afterwards.
The bottom line
Section 5, current account: transactions are freely permitted unless the Government restricts them, under the Current Account Transaction Rules, 2000.
Section 6, capital account: transactions are permitted only to the extent the RBI or Central Government rules allow — the NDI Rules, 2019 and the debt regulations.
The regulators split: the Central Government, through DPIIT and the Ministry of Finance, governs non-debt instruments. The RBI governs debt instruments and administration. The Enforcement Directorate investigates and adjudicates contraventions.
Residence is not citizenship. Section 2(v) turns on days in India read with intent.
The two-account architecture
Sections 2(e), 2(j), 5 and 6 of FEMA, 1999 sort every cross-border transaction into one of two boxes, and the presumption flips between them.
Current account transactions under Section 2(j) are those other than capital account transactions: payments for trade, short-term banking and credit facilities in the ordinary course, interest on loans, net income from investments, living expenses of family abroad, travel, education, medical expenses. Under Section 5 these are free, subject only to the Foreign Exchange Management (Current Account Transactions) Rules, 2000, which:
- prohibit a short list outright in Schedule I — remittances out of lottery winnings, income from racing or riding, purchase of lottery tickets or prohibited magazines, payment of commission on exports towards equity investment in joint ventures abroad, and the like;
- require Central Government approval for Schedule II items; and
- require RBI approval above monetary limits for Schedule III items.
Capital account transactions under Section 2(e) are those that alter assets or liabilities, including contingent liabilities, outside India for a person resident in India, or in India for a person resident outside India. Foreign investment, borrowing, lending, guarantees, acquisition and transfer of immovable property, and the export or import of currency all sit here. Under Section 6 they are permissible only as specifically allowed.
The classification is the whole answer, which is why substance beats labelling. A payment described in the contract as a royalty or a service fee is a current account transaction and freely remittable. If it is in substance the repatriation of capital, or if no real underlying agreement supports it, it is neither — and Section 4 on holding foreign exchange, together with the banker-diligence obligations in Section 10(4) and (5), comes into play. Enforcement actions against large multinationals in India have turned on exactly this re-characterisation.
Who regulates what, after 2015
The Finance Act, 2015 rebalanced the rule-making powers in Section 6(2A) and 46/47. The architecture since then:
- Central Government, through the Ministry of Finance with DPIIT policy: non-debt instruments — equity shares, fully or compulsorily convertible instruments, LLP capital, immovable property, investment vehicles — under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019.
- RBI: debt instruments, meaning External Commercial Borrowings, NCDs and deposits, plus the Mode of Payment and Reporting of Non-Debt Instruments Regulations, 2019, and day-to-day administration through AD Category-I banks and the FIRMS portal.
- Enforcement Directorate: investigation, search and seizure under Section 37 and 37A, and adjudication of penalties under Section 13.
- Authorised Dealer banks: the front line. They process every remittance and filing, and carry their own obligations under Section 10(4) and (5) to verify that a transaction complies.
Residential status, the gateway question
FEMA residence has nothing to do with citizenship, and it is not the Income-tax Act's test either. Section 2(v) and 2(w) make a person resident in India, broadly, someone who resided here for more than 182 days during the preceding financial year — subject to purpose and intent.
Those last three words do the work. Someone leaving India for employment, business, or a stay of uncertain duration becomes a person resident outside India essentially from departure. Someone arriving to take up employment or for an indefinite stay becomes resident from arrival, whatever the day count says.
Dual status is the classic trap. An Indian citizen working in Dubai is a non-resident under FEMA, so their Indian savings account has to be re-designated NRO and their investments follow non-resident rules, even where they are a resident under the Income-tax Act for that year. Two statutes, two tests, two sets of consequences — and a failure to re-designate surfaces years later, during a property sale or a repatriation.
Prohibitions that sit outside the account structure
Sections 3 and 4 apply whichever side of the current/capital line a transaction falls on, and they are the provisions that carry the sharpest consequences.
- Section 3(a): no person shall deal in or transfer foreign exchange or foreign security to anyone other than an authorised person. This is the hawala provision, and it is the one contravention the RBI cannot compound. It goes to the ED.
- Section 3(b) to (d): no unauthorised payments to or for the credit of persons resident outside India, no receipt of payments on their behalf, and no financial transaction in India as consideration for acquiring an asset abroad.
- Section 4: no person resident in India shall acquire, hold, own, possess or transfer any foreign exchange, foreign security or immovable property situated outside India, except as permitted. Where Section 4 is contravened, Section 37A lets the ED seize equivalent Indian assets.
A worked example
An Indian software company needs to send ₹2 crore to its US parent.
If the payment is licence fees for software used in the ordinary course, supported by an executed agreement and invoices, it is a current account transaction under Section 5. It goes out through the AD bank on Form A2 with a 15CA/15CB tax certificate, and nobody needs to approve it.
If the same ₹2 crore is in substance a return of capital on shares the parent holds, it is a capital account transaction. It is permissible only through a buyback, a capital reduction or a share transfer that complies with the NDI Rules, the pricing guidelines and FC-TRS reporting.
Same money, same counterparty, opposite legal treatment. Companies that document the second as the first are the exact profile the ED pursues under Sections 4 and 37A.
Common mistakes
- Applying the income-tax residence test to FEMA. Section 2(v) is a different test, turning on the preceding financial year read with purpose and intent.
- Assuming current account means anything routine. Schedules I to III of the 2000 Rules prohibit or cap several ordinary-looking remittances.
- Forgetting to re-designate accounts on a change of status: savings to NRO on becoming non-resident, NRE to a resident account on returning.
- Treating the AD bank's clearance as legal cover. The bank's diligence does not immunise the remitter, and both can be proceeded against.
- Looking for equity rules in the RBI regulations rather than the NDI Rules 2019, which is where the 2015 split put them.
- Papering capital repatriation as fees. Substance over form is the single largest FEMA exposure for the Indian subsidiary of a foreign group.
Frequently asked questions
Is FEMA a criminal law? No. Contraventions are civil and penalised under Section 13. FERA, its predecessor, was criminal. Only wilful non-payment of a FEMA penalty can lead to civil imprisonment.
Who decides FDI policy, the RBI or the Government? Since 2015, the Central Government makes the rules for non-debt instruments, through the NDI Rules, 2019 with DPIIT policy. The RBI governs debt instruments, mode of payment and reporting.
Am I a resident under FEMA if I hold an Indian passport? Not necessarily. Citizenship is irrelevant. The test is days in the preceding financial year, read with the purpose of your stay or departure.
Can all FEMA contraventions be compounded? No. Section 3(a) contraventions sit outside the RBI's compounding power, and matters involving suspected money laundering, terror financing or threats to national integrity are referred for adjudication.
What is an Authorised Dealer bank? A bank licensed by the RBI under Section 10 to deal in foreign exchange. It is your mandatory channel for cross-border payments and FEMA filings.
What records should we keep? Agreements, invoices, FIRCs and valuation certificates, alongside the FC-GPR, FC-TRS, FLA, ECB-2 and APR filings as applicable. The ED's questions tend to arrive years after the payment.
Primary sources
- Sections 2(e), 2(j), 2(v), 3, 4, 5, 6, 10, 13 and 37A, Foreign Exchange Management Act, 1999
- Foreign Exchange Management (Current Account Transactions) Rules, 2000
- Foreign Exchange Management (Non-Debt Instruments) Rules, 2019
- Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019
- Consolidated FDI Policy Circular of 2020, as amended