Violation and Misuse of the FEMA

Syllabus: GS2/Government Policy & Interventions; Statutory Body; GS3/Security Issues

Context

• Recently, the Enforcement Directorate (ED) has issued an adjudication order imposing a penalty of over ₹3.44 crore on BBC World Service India (BBC WS India) for alleged violations of the Foreign Exchange Management Act (FEMA) of 1999.
  • BBC WS India, classified as a 100% Foreign Direct Investment (FDI) company, was found to be in violation of Indian regulations that mandate a cap of 26% FDI for digital media entities under the government approval route.

About the Foreign Exchange Management Act (FEMA), 1999

• It was enacted to replace the Foreign Exchange Regulation Act (FERA), 1973, which was considered too restrictive.
• It was enacted in response to India’s economic liberalization in the 1990s and aimed to ensure compliance with global financial norms, and to facilitate external trade and payments while ensuring the orderly development and maintenance of the foreign exchange market in India.
• The Reserve Bank of India (RBI) and the Enforcement Directorate (ED) are the primary regulators enforcing FEMA.

Key Provisions of FEMA

• Current and Capital Account Transactions: While current account transactions (trade, remittances, etc.) are generally allowed, capital account transactions (investment in foreign assets, debt instruments, etc.) require RBI approval.
• Regulation of Foreign Exchange Holdings: FEMA permits Indian residents to hold foreign exchange within specified limits but prohibits unauthorized dealings.
• Restrictions on Foreign Direct Investment (FDI): FEMA governs the inflow and outflow of FDI in India through RBI and government policies.
• Penalties for Non-Compliance: Violators face monetary fines, asset seizures, and, in severe cases, criminal action under the Prevention of Money Laundering Act (PMLA).

Penalties for Violations

• FEMA is a civil law, meaning violations result in monetary penalties, not criminal charges.
  • The ED can impose penalties up to three times the amount involved in the violation.
• Compounding of Offenses: FEMA violations can be settled through a compounding process under RBI’s supervision, avoiding prolonged litigation.

Common Violations and Misuse of FEMA

• Hawala Transactions: Hawala is an illegal remittance system used to transfer money outside the formal banking network, violating FEMA provisions.
• Round-Tripping: It involves sending funds abroad and bringing them back as FDI to take advantage of tax benefits and hide the source of income.
  • It is particularly common in tax havens like Mauritius, the Cayman Islands, and Singapore.
• Unauthorized Foreign Remittances: Many businesses and individuals violate FEMA by remitting funds abroad without RBI permission.
  • For instance, some companies invest in offshore entities without reporting to the authorities, leading to foreign exchange loss for India.
• Money Laundering Through Shell Companies: Shell companies are used to disguise illegal foreign investments.
  • FEMA violations often involve creating bogus companies abroad, routing illicit funds, and repatriating them under the guise of legitimate transactions.
• Crypto-Related Violations: With the rise of cryptocurrency, many individuals and entities use digital assets to transfer funds outside India without RBI approval, violating FEMA norms.
• Violation of Liberalized Remittance Scheme (LRS): An Indian resident can remit up to $250,000 per financial year for permissible foreign transactions under LRS.
  • However, many individuals misuse LRS by exceeding limits or using funds for speculative trading in foreign stock markets without proper declarations.

Challenges in Enforcing FEMA

• Difficulty in Tracking Offshore Transactions: Many violations involve complex money flows through multiple offshore accounts, making it difficult for Indian regulators to track illicit activities.
• Limited Coordination Between Agencies: While FEMA is regulated by RBI and ED, coordination with tax authorities, SEBI, and other regulatory bodies remains a challenge.
  • Multiple agencies like RBI, SEBI, and CBI also regulate forex violations, leading to bureaucratic hurdles.
• Use of New-Age Financial Instruments: The rise of digital banking, cryptocurrencies, and fintech startups has created new avenues for FEMA violations that traditional enforcement mechanisms struggle to address.
• Globalization and Tax Havens: India’s high net-worth individuals (HNIs) and corporates often use tax havens to evade FEMA regulations, requiring stronger global cooperation to tackle violations.

Recommended Reforms

• Stricter Penalties: Higher financial penalties and stringent criminal actions against offenders can deter future violations.
• Better Surveillance Mechanisms: AI and big data analytics can be used to track suspicious foreign transactions.
• Stronger International Cooperation: India should enhance collaboration with global financial regulators to track money laundering.
• Regulation of Cryptocurrencies: Clear guidelines and regulations are needed to prevent crypto-related FEMA violations.

Source: TH