Capital and Current Account Transactions under FEMA: An Overview

Prabhat Nigam

09 Jun, 2022

While working on different kinds of transactions involving investments, acquisitions, residents, non-residents etc., it needs to be checked whether such transactions are permissible under the framework of the Foreign Exchange Management Act (FEMA), Foreign Exchange Management Rules and other related notifications, circulars, notices etc. Since law cannot provide every permissible and impressible transaction so the law has made things simpler by classifying every such transaction into two broad categories of Capital and current account transactions under FEMA.   

Capital and Current Account Transactions

Both the capital and current account transactions form the base of FEMA. All the transactions involving a resident and non-resident are classified as capital and current account transactions.

The golden rule for identifying a transaction as capital account transaction is that unless a transaction is specifically permitted, it is prohibited under FEMA and the golden rule to identify a current account transaction is that a particular transaction is permitted unless specifically prohibited by or specifically regulated by FEMA.

Though the above definition is easy and simple enough to understand, but applying the same is not an easy task because of subjective interpretations of the definitions of both capital and current account transactions.

What is a current account transaction?

A current account transaction has been defined as a transaction other than capital account transactions and includes transactions such as payments which are due in connection with foreign trade, other current business, services, short term banking and credit facilities taken in the ordinary course of business, payments which are due as interest on loans and also as net income from investments, remittances sent for the living expenses of parents, spouse and children who are residing abroad and also the expenses in relation to education, foreign travel and medical care of parents, spouse and children.

What is a capital account transaction?

A capital account transaction is a very subjective definition and comprises of such transactions which alter the ‘assets’ or ‘liabilities’ and also includes ‘contingent liabilities’ of both non-residents in India and residents outside India. Section 6(3) also provides for the regulated capital account transactions such as transfer or issue of any Indian security by a non-resident, transfer or issue of foreign security by an Indian resident, borrowing or lending etc.

It must be noted that the terms such as “assets”, “liabilities” and “contingent liabilities” have not been defined under FEMA making it difficult to determine whether a transaction constitutes a capital account transaction or not. A quick response to find the meaning of the said terms is to look for their meanings in the accountancy practice. However, RBI has not prescribed whether the said practice would be right approach to determine the meanings of these terms.

There are many situations where a particular transaction may under the ‘grey’ area of permissibility under FEMA. Some of these transactions have been mentioned below. In all these examples, one needs to determine whether they fall under the category of capital account transactions or current account transactions.

• Exclusivity fee:

1. Exclusivity fee paid during a corporate transaction of acquisition or an investment transaction is usually paid to ensure that a party to whom this fees is paid is restricted from negotiating the same kind of transaction with other party for a specific period of time.
2. There is no provision under FEMA which provides for payment of exclusivity fee between a non-resident and resident. Since the exclusivity fee is linked to a transaction involving equity instruments of Indian economy which is a capital account transaction. Therefore, such payments should be treated as capital account transactions which should have ideally been permitted under FEMA.
3. The exclusivity can also be used to set-off the against the purchase consideration payable by the buyer. In this case, it will be treated as a capital account transaction and in case where the exclusivity fee is not set-off as the purchase consideration, then such payment can be categorised as a capital account transaction.

• Non-compete fee:

1. Payment of non-compete fees has been in vogue particularly after changes have been made in regulations involving listed company transactions. This non-compete fee is paid by the purchaser to the seller in order to restrict the seller or other person from competing with the purchaser for a specific period.
2. Since this non-compete fees is linked to purchase and sale of shares, it could also be treated as a capital account transaction and not covered within the general permission of RBI^[1].

• Damages and indemnities:

1. According to the Foreign Exchange Management (Non-debt instruments) Rules, 2019 provide that in case of transfer of instruments between a non-resident and a resident where the amount not exceeding 25% of the total consideration may be paid as indemnity by the seller to the buyer within a period not exceeding 18 months from the date of payment of full consideration, if the full consideration has been paid by the purchaser to the buyer.
2. Apart from the abovementioned, FEMA does not expressly allow or disallow payment on account of indemnity or damages for a share subscription or share acquisition transaction in a transaction where sale and purchase of or subscription of equity instruments is taking place.
3. If payment of damages can be termed as current account transactions, then such a payment between non-residents and residents would be permitted since payment of damages has not been expressly prohibited.