What Foreign Investors Must Know About India’s FEMA Regulations

Foreign Exchange Management Act, 1999 (FEMA) compliance for foreign investment in India is essential for startups, exporters, and subsidiaries engaging in cross-border transactions. This guide explains rules under the latest Reserve Bank of India (RBI) framework, including foreign direct investment (FDI), external commercial borrowings (ECBs), overseas direct investment (ODI), reporting forms, and penalties for non-compliance.

India’s appeal as a destination for foreign investment is growing. To govern increasing cross-border capital flow, India’s FEMA sets rules for FDI routes, ECBs, ODI, and remittances.

Any individual or company engaging in foreign exchange transactions, from startups to exporters and non-resident Indians (NRIs), must comply with FEMA requirements. It is regulated by India’s central bank, the Reserve Bank of India (RBI), through its periodic notifications.

FEMA rules for FDI

Companies bringing FDI into India must take either the automatic route or the government approval route. The automatic route permits 100 percent FDI without prior approval in sectors like software and manufacturing. In contrast, the government route requires clearance for investments in sectors such as defense (above 74 percent), retail, and print media.

Pricing guidelines and timelines

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When an Indian company issues shares or convertible instruments to non-residents, it must follow pricing norms set by the RBI. For unlisted companies, the valuation must be conducted by a Securities and Exchange Board of India (SEBI)-registered Category I Merchant Banker or a Chartered Accountant (CA).

As the foreign investment is received, shares must be allotted within 60 days. If this deadline is missed, the funds need to be returned to the investor within 15 days after the end of the 60-day window.

FEMA requires these form filings for FDI transactions to be completed within the deadline. Once shares are allotted to a foreign investor, the company must file Form FC-GPR within 30 days. In cases involving the transfer of shares between residents and non-residents, Form FC-TRS must be submitted within 60 days of the transaction.

The Single Master Form, available on the RBI’s FIRMS portal, brings all FDI-related reporting into a single platform. Separately, companies that have received foreign investment must submit the Foreign Liabilities and Assets (FLA) return annually by July 15.

If an Indian company holds investments abroad, it is also required to file an Annual Performance Report (APR) for each foreign entity in which it holds equity.

Entities and transactions covered under FEMA

FEMA compliance is compulsory for entities and transactions engaged in foreign exchange or cross-border capital transactions. This includes Indian companies that receive FDI or undertake outbound investments.

Foreign subsidiaries that operate in India are also covered under FEMA requirements, especially for capital inflows and financial transactions with their parent companies. Startups that raise funding from overseas investors also fall under FEMA’s purview for reporting norms and duties.

Exporters and importers who deal in foreign currency are required to meet FEMA’s documentation and remittance rules. NRIs and Persons of Indian Origin (PIOs) who invest in Indian businesses or remit funds into India also need to follow the conditions given in FEMA.

Compliance needs for foreign subsidiaries in India

Foreign subsidiaries incorporated in India are treated as domestic entities under FEMA. As such, they must comply with the standard reporting and operational procedures applicable to Indian companies receiving foreign investment. When capital is infused by the parent company or any foreign shareholder, the subsidiary must file Form FC-GPR within 30 days of allotting shares. Inter-company transactions must follow arm’s length pricing rules to ensure compliance with transfer pricing laws.

Arm’s length pricing means transactions between related parties should be conducted as if they were unrelated parties.

If a foreign subsidiary makes investments into other Indian companies, it must also comply with FEMA rules for indirect foreign investments, such as sectoral caps and reporting. In addition, subsidiaries are required to file their Foreign Liabilities and Assets (FLA) return annually and ensure that their Single Master Form is kept updated on the RBI’s FIRMS portal.

Guidelines for startups receiving foreign investments

Startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), as well as unregistered startups that raise funds from foreign investors, fall under FEMA’s regulatory purview. These entities are supposed to follow pricing rules and valuation methods when issuing shares or convertible instruments.

If issuing convertible notes, each note must be backed by a minimum investment of INR 2.5 million (US$28,540) per foreign investor per investment and must be converted into equity within five years. Startups are required to file the necessary disclosure documents, like Form CN for convertible notes, and comply with the timelines set by the RBI.

Compliance duties of export-import transactions

Businesses engaged in cross-border trade are subject to transaction-level FEMA compliance. Exporters of goods must do the following:

• Register for Importer Exporter Code (IEC);
• File shipping bills and Export Declaration Form with the relevant authorities;
• Ensure that proceeds from the export of goods are realized within nine months from the date of shipment, although this period can be extended on a case-by-case basis; and
• Provide banks with proof of remittance and Foreign Inward Remittance Certificates (FIRCs) to validate the transaction.

For export of services, please follow these guidelines:

• Submit SOFTEX forms, especially in the software and consulting sectors, through the nodal agencies such as Software Technology Parks of India (STPI) or Special Economic Zones (SEZs); and
• Maintain records of contracts and communication with foreign clients and ensure proper invoices and payment receipts.

On the import side, remittances for goods and services must be routed through banks authorized by the RBI. Importers are required to submit Form A2 before initiating outward remittances. They must also provide supporting documents like purchase orders, invoices, and Bills of Entry (BoE). It is important to ensure there is no delay in payment or gaps in foreign exchange, since it may invite further scrutiny and may lead to penalties.

FEMA guidelines for External Commercial Borrowings

External Commercial Borrowings (ECBs) allow Indian companies to raise debt from foreign lenders. And these loans come with defined eligibility and reporting conditions.  The lenders could be international banks, financial institutions, and foreign equity holders who hold at least a 25 percent direct stake in the borrowing company.

Maturity requirements for ECBs are based on the size of the borrowing:

• ECBs of up to US$50 million must have a minimum average maturity of three years;
• ECBs above the US$50 million threshold require a five-year minimum maturity; and
• Companies can raise ECBs up to US$3 million per financial year under the automatic route, beyond which prior approval is required.

Permitted end uses for ECB proceeds are capital expenditure, refinancing of existing loans, and the import of capital goods. However, using ECB funds for investment in real estate, the purchase of equity instruments, or capital market activities is prohibited.

RBI has asked all ECB transactions to be routed only through its Authorized Dealer (AD) banks. The borrowers should submit Form ECB at the time of taking down the loan, followed by monthly Form ECB-2 filings to report ongoing actual use.

Rules for overseas direct investments

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Overseas Direct Investment (ODI) by Indian companies is governed by the 2022 FEMA amendments. Indian companies are permitted to invest in foreign joint ventures (JVs) or wholly owned subsidiaries using equity, debt, or guarantees. However, investments in sectors such as real estate or banking are not allowed unless specifically approved. Only Indian companies that are registered and in good regulatory standing are eligible to invest.

Filing obligations under ODI are namely:

• Submitting Form FC within 30 days of making the investment;
• Filing the Annual Performance Report (APR) by December 31 each year;
• In cases involving acquisitions, ensuring that the valuation of the overseas entity is conducted and certified by a qualified professional.

Regulations on inward remittances

Inward remittances refer to foreign funds received by Indian organizations as payment for exports or services like consultancy. Under FEMA, all such remittances must be routed exclusively through RBI-certified AD banks. The receiving company must obtain a FIRC as proof of receipt.

The receiving company is required to declare the source and intended end-use of funds and keep supporting documents like contracts, invoices, and declarations. The RBI also requires that the sender of the funds be verified under Know Your Customer (KYC) norms, and all transactions must meet anti-money laundering (AML) standards.

In cases where remittances are received and shares are allotted in return, the transaction must be reported to the RBI through Form FC-GPR within 30 days of allotment.

Penalties for non-compliance

Not complying with FEMA provisions can attract:

• Penalties of up to three times the amount involved or INR 200,000 (US$2,284.2), whichever is higher;
• For continuing violations, a daily fine of INR 5,000 (US$57.1); and
• In serious cases, the RBI may reverse the transaction or restrict the company from raising foreign capital.

Therefore, companies need to ensure proper reporting, pricing, and documentation. This can be achieved with the help of investment and FEMA professionals.

In short

Foreign investment into India operates within the rules shaped by FEMA and RBI notifications. While the compliance requirements may appear document-heavy and time-sensitive, they apply equally to listed firms, startups, and subsidiaries, thereby ensuring transparency.

(US$1 = INR 87.61)

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