The Foreign Exchange Management Act (FEMA) was enacted in 1999, replacing the Foreign Exchange Regulation Act (FERA), to consolidate and amend the laws related to foreign exchange and facilitate external trade and payments, besides promoting the orderly development of the foreign exchange market. FEMA regulates two types of foreign exchange transactions — capital account and current account. In general, all current account transactions under FEMA are permitted except those specified. Additionally, all capital account transactions are prohibited or regulated except those specified.

As FEMA is intended to manage foreign exchange (and not regulate it like FERA), parties undertaking cross-border transactions should adhere to the prescribed compliances or seek approval, where needed. For example, when shares of an Indian company are transferred by a resident to a non-resident, the price cannot be less than the value computed on the basis of the DCF (discounted free cash flow) method. Further, the transfer details should be filed with the Reserve Bank of India through an authorised dealer in Form FC-TRS within 60 days from receipt of consideration.

Although FEMA, unlike FERA, does not carry draconian provisions, any contravention could result in penalty. FEMA prescribes a penalty up to thrice the sum involved where it is quantifiable, or up to Rs 2 lakh where it is not quantifiable. Further, if the contravention continues, an additional penalty of Rs 5,000 a day is levied.

Given the penal implications, FEMA contains provisions permitting compounding of contraventions. Compounding refers to the process of voluntarily admitting to contravention, pleading guilty and seeking redressal. The compounding provisions are designed to provide comfort to citizens and the corporate community by minimising transaction costs, even while taking a severe view on wilful, mala fide, and fraudulent transactions.

A compounding application is made to the RBI Compounding Authority in the prescribed format, along with the necessary documents and a demand draft for Rs 5,000. It is important to note that compounding is possible only after rectifying the records by obtaining post-facto approvals or unwinding the transactions that are not permissible under FEMA. Accordingly, all requisite approvals/ compliances should be completed before seeking compounding.

The Compounding Authority decides, on a case-to-case basis, whether the contravention is technical, material, or sensitive in nature. Where it is technical, the applicant may be issued a cautionary advice. When it is material, the contravention is compounded by imposing a penalty after giving the contravener an opportunity for a personal hearing. However, where the contravention is sensitive in nature and requires further investigations, it is referred to the Directorate of Enforcement. Prima facie , sensitive contraventions include money laundering and national and security concerns involving serious infringement of the regulatory framework.

In passing the compounding order and determining the quantum of penalty, the factors taken into consideration include

the amount of unfair advantage gained, where quantifiable;

the loss to any authority/ agency/ exchequer;

economic benefits accrued from delayed compliance or avoidance;

history of non-compliance;

contravener’s conduct in undertaking the transaction, and disclosure of full facts in the submissions during the personal hearing;

whether contravenersuo motu approached the RBI with the defaults; and so on.

The process concludes when the Compounding Authority passes an order indicating the provisions of FEMA contravened, along with the sum payable for compounding it. It is pertinent to note that an offence cannot be compounded if a similar contravention was committed within three years.

The RBI is keeping a watchful eye on non-compliances. In practice, it is observed that where a person suo motu approaches the RBI for compounding, the Authority generally takes a pragmatic view, subject to the nature of the contravention. Accordingly, it is vital for individuals and organisations to identify their non-compliances and thereafter voluntarily approach the RBI to regularise the contraventions — this could help minimise the penal consequences.

Sanjay Chauhana, Chartered Accountant contributed to the article.

The author is a chartered accountant

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