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, not 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 — without a criminal record.
For a founder raising a round 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. Get the classification wrong and the money may be legally unremittable — and no amount of commercial logic will fix it after the fact.
BOTTOM LINE
- Section 5 (current account): transactions are freely permitted unless the Government restricts them (Current Account Transaction Rules, 2000).
- Section 6 (capital account): transactions are permitted only to the extent allowed by RBI/Central Government rules — the NDI Rules, 2019 and Debt Regulations.
- Regulators split: the Central Government (DPIIT/MoF) 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 plus intent.
The two-account architecture
Governs this section: Sections 2(e), 2(j), 5 & 6, FEMA, 1999
Every cross-border transaction is either a current account transaction or a capital account transaction, and the presumption flips between them.
Current account transactions (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 and medical expenses. Under Section 5, these are free — subject only to the Foreign Exchange Management (Current Account Transactions) Rules, 2000, which:
- prohibit a small list outright (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 JVs abroad, and similar);
- require Central Government approval for Schedule II items; and
- require RBI approval above monetary limits for Schedule III items.
Capital account transactions (Section 2(e)) are those that 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. Foreign investment, borrowing, lending, guarantees, acquisition and transfer of immovable property, and export/import of currency all sit here. Under Section 6, these are permissible only as specifically allowed.
CAUTION — the classification decides the answer
A payment described in the contract as a "royalty" or "service fee" is a current account transaction and freely remittable. If it is in substance the repatriation of capital or unsupported by any real underlying agreement, it is neither — and Section 4 (holding foreign exchange) plus Section 10(4)/(5) banker-diligence obligations come into play. Enforcement actions against large multinationals in India have turned on exactly this re-characterisation.
Who regulates what — the 2015 split
Governs this section: Section 6(2A) & 46/47, FEMA, 1999 (Finance Act, 2015 amendment)
Since the Finance Act, 2015 rebalanced rule-making powers, the architecture is:
- Central Government (Ministry of Finance, with DPIIT policy): non-debt instruments — equity shares, fully/compulsorily convertible instruments, LLP capital, immovable property, investment vehicles — governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules").
- RBI: debt instruments (External Commercial Borrowings, NCDs, deposits), 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 (ED): investigation, search, seizure under Section 37/37A, and adjudication of penalties under Section 13.
- Authorised Dealer (AD) banks: the front line — they process every remittance and filing, and carry their own Section 10(4) and 10(5) obligations to verify that transactions comply.
Residential status — the gateway question
Governs this section: Section 2(v) & 2(w), FEMA, 1999
FEMA residence has nothing to do with citizenship and is not the same test as the Income-tax Act's. A person resident in India is broadly someone who resided in India for more than 182 days during the preceding financial year — but that is subject to purpose and intent. A person who leaves India for employment, business or an uncertain-duration stay abroad becomes a person resident outside India essentially from departure; conversely, someone arriving to take up employment or an indefinite stay becomes resident from arrival, regardless of the 182-day count.
PRACTITIONER'S NOTE
Dual status is the classic trap. An Indian citizen working in Dubai is a non-resident under FEMA (so his Indian savings account must be re-designated NRO, and his investments follow non-resident rules) even if he is a resident under the Income-tax Act in a given year. Two statutes, two tests, two sets of consequences — and re-designation failures surface years later during a property sale or repatriation.
Prohibitions that sit outside the account structure
Governs this section: Sections 3 & 4, FEMA, 1999
- Section 3(a): no person shall deal in or transfer foreign exchange or foreign security to anyone other than an authorised person — the hawala provision. This is the one contravention that cannot be compounded by the RBI; it goes to the ED.
- Section 3(b)–(d): no unauthorised payments to or for the credit of persons resident outside India, no receipt of payments on their behalf, and no entering into financial transactions in India as consideration for acquiring assets 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. Section 37A empowers the ED to seize equivalent Indian assets where Section 4 is contravened.
Worked example
Mini-case — one payment, two different answers
An Indian software company must send ₹2 crore to its US parent. If the payment is licence fees for software used in the ordinary course, backed by an executed agreement and invoices, it is a current account transaction under Section 5 — freely remittable through the AD bank on Form A2 with a 15CA/15CB tax certificate. If the same ₹2 crore is in substance a return of capital on shares the parent holds, it is a capital account transaction — permissible only through a buyback, capital reduction or share transfer that complies with the NDI Rules, pricing guidelines and FC-TRS reporting. Same money, same counterparty, opposite legal treatment. Companies that paper the second as the first are exactly the profile the ED pursues under Sections 4 and 37A.
Common mistakes
- Applying the Income-tax residence test to FEMA. They are different — Section 2(v) turns on the preceding financial year plus purpose and intent.
- Assuming "current account = anything routine". Schedules I–III of the 2000 Rules prohibit or cap several ordinary-looking remittances.
- Forgetting to re-designate accounts on becoming non-resident (savings → NRO) or resident (NRE → resident account).
- Treating the AD bank's clearance as legal cover. The bank's due diligence does not immunise the remitter; both can be proceeded against.
- Ignoring the 2015 split and looking for equity rules in RBI regulations rather than the NDI Rules, 2019.
- Papering capital repatriation as fees. The substance-over-form risk is the single largest FEMA exposure for MNC subsidiaries.
Checklist
- Classify every cross-border transaction: current account (Section 5) or capital account (Section 6).
- For current account items, check Schedules I, II and III of the Current Account Transactions Rules, 2000.
- For capital account items, identify the governing instrument: NDI Rules 2019 (non-debt) or RBI debt regulations.
- Determine FEMA residential status independently of income-tax residence; re-designate bank accounts on status change.
- Route every transaction through an AD Category-I bank with complete underlying documentation.
- Diarise reporting: FC-GPR, FC-TRS, FLA, ECB-2, APR as applicable.
- Preserve agreements, invoices, FIRCs and valuation certificates — the ED's questions arrive years later.
FAQ
Is FEMA a criminal law? No. FEMA contraventions are civil, 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 — RBI or the Government? Since 2015, the Central Government makes rules for non-debt instruments (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. Contraventions of Section 3(a) are outside 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 — your mandatory channel for cross-border payments and FEMA filings.
Primary sources
- Sections 2(e), 2(j), 2(v), 3, 4, 5, 6, 10, 13 & 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)
Disclaimer: This article is general information on a fast-changing area of exchange-control law, current at the time of writing. It is not legal or professional advice. Rules, schedules and limits change through RBI circulars and DPIIT press notes — verify the live position and consult your AD bank and counsel before remitting or filing.