Demystifying FEMA - A Primer on Liberalised Remittance Scheme (LRS)

In February 2004, Reserve Bank of India intorduced the scheme of Liberalised Remittance Scheme. This scheme permitted remittance by resident individuals for permitted current and capital account transactions. The annual permitted limit was USD25,000/- per calendar year.
This limit was in addition to various limits prescribed under private travel,  medical expenses, education abroad, gift etc, which were detailed in schedule 3 of Foreign Exchange Management Current Account Transactions Rules (FEM CAT Rules).
Over a period of 11 years, this scheme has been tweaked many times to suit the prevalent circumstances and further liberalisation. The elegible period was changed from calendar year to financial year in 2006.

Reserve Bank of India, in its review of Monetary Policy of February 2015 indicated its intentions of raising the limit from prevailing USD 125000/- to USD 250000/-. However, the formal announcement on 1st June 2015 implementing the revised limit was much more than the revision of limit. All other limits available for travel, education, medical expenses, gifts etc. have been subsumed under the overall limit of USD 250000/-.

Thus from now on in any financial year the limit available for any elegible current or capital account transaction is USD 250000/-. On production of documentary evidence exceptions have been made for three specified expenses (1) Medical Treatment, (2) Education and (3) Emigration.

Another improvement in the scheme is regarding the restriction of noimnating an Authorised Dealer. Earlier, the individual was tied up with a particular Authorised Dealer for the entire year. Now the system has been liberalised and the individual has to give a declaration regarding not violating the limit of USD 250000/-.

A word of caution is that the funds to be remitted have to be own funds. These should not be borrowed funds and no bank is permitted to extend credit or sanction limit for the purpose of LRS.

Thus the permissible capital account transactions by an individual under LRS are:
i) opening of foreign currency account abroad with a bank;
ii) purchase of property abroad;
iii) making investments abroad;
iv) setting up Wholly owned subsidiaries and Joint Ventures abroad;
v) extending loans including loans in Indian Rupees to Non-resident Indians (NRIs) who are relatives as defined in Companies Act, 2013.

The revised LRS has put a lot of onus and faith on the individuals. The adherence to the annual limit and ensuring end use is now the responsibility of the individual. The concerned AD bank will only ask for a declaration. The remittance should not be to a country which is not a signatory to FATF agreement.

Facilities for persons other than individuals:

Persons other than individuals can make remittances for

1. Donations for educational institutions - 1% of Forex earnings during last 3 years or USD 5 mio whichever is less
2. Commissions to agents abroad for sale of residential flats/commercial plots in India - 5% of inflow or USD 25,000 whichever is higher
3. Remittances for consultancy services - USD 10 mio for infrastructure project and USD 1 mio for other projects
4. Remittances for reimbursement of pre-incorporation expenses - 5% of Investment inflow or USD 1 mio, whichever is higher

The RBI circular of June 1, 2015 also reads:
"provided also that a person other than an individual may also avail of foreign exchange facility, mutatis mutandis, within the limit prescribed under the said Liberalised Remittance Scheme for the purposes mentioned herein above"
Which implies that LRS has been extended to persons other than individuals.

Demystifying FEMA - The Basics

Let us start with the Fundamentals. FDI in India is guided by the Consolidated FDI Policy Circular of 2015 of Government of India in this regard.

Who can Subscribe to Security: Any entity resicent outside India can invest in securities of Indian entity with some exceptions. Residents of Bangladesh have to take approval from Foreign Investment Promotion Board (FIPB). Residents of Pakistan, apart from taking approval from FIPB, are prohibited from investing in specific sectors. Residents of Nepal and Bhutan can invest only in non-repatriable form.

Types of Instruments that can be issued: Indian companies can issue equity shares, fully and mandatorily convertible debentures, fully and mandatorily convertible preference shares and warrants. From December 30, 2013 optionally convertible instruments have also been permitted. Guiding principle for optionally convertible debentures is that there has to be a lock-in period of 1 year and there should be no assured return. (price not exceeding that arrived at on the basis of Return on Equity (RoE) as per the latest audited balance sheet. This condition has been removed.). The exit price should not be higher than the fair value of shares as determined by a Chartered Accountant or Merchant Banker registered with SEBI based on any Internationally acceptable methodology.

The Issue Price of Security: Under FDI fresh Shares to be issued to Non-residents should not be at a price less than the Fair Value. Fair Value of shares of a listed company is as prescribed by SEBI guidelines. In case of unlisted companies, it is as determined by a SEBI registered Merchant Banker or a Chartered Accountant as per as per any internationally accepted pricing methodology on arm’s length basis. If we see old instructions, earlier it used to be as prescribed under CCI guidelines. This was later modified to Discounted Cash Flow method.

Other Ways of Acquiring Equity: Equity can be subscribed to by converting Debentures and Preference Shares. Non-Convertible Debentures are not treated as FDI. The conversion price of Debenture has to be decided upfront. This can be a predetermined fixed value or it can be based on a formula. The guiding principle of conversion price is that it can not be less than the fair value of equity prevailing on the date of issue of debenture.

Compliance with other Acts: The company has to submit a certificate (format prescribed in FEMA20) from a Company Secretary regarding compliance with the Companies Act and any other conditions that might have been imposed by Government of India.
 

Demystifying FEMA

A business can get long term funds in the form of Equity or Loan or Hybrid instruments.
If a company desires to get these finds from offshore sources, it has to comply with various FEMA requirements. These requirements are spread over numerous FEMA Notifications issued by the Reserve Bank of India.

In this and a series of following posts, I would try to demystify these notifications. A word of disclaimer becomes necessary. The views expressed here are purely personal and the ruling of RBI would be final. The contents of any of my blog should not be taken as professional advice. This is for academic discussion only.

Most common form of long term funds is Equity. Equity can be accessed in Direct or Indirect form. Indirect form of equity means Portfolio Investment by Qualified Institutional Investors.

The relevant instructions regarding Direct participation in equity can be found in a document commonly known as FEMA 20. (Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 Notification No. FEMA 20 /2000-RB dated 3rd May 2000). In past 15 years this notification has been amended numerous times. Thankfully, RBI consolidates its instructions and publishes them in the form of a Master Circular. These instructions are issued by the name "Master Circular on Foreign Investment in India"

The broad provisions under FEMA for issuance of Equity instruments are that the reporting of receipt of funds from abroad has to be done to RBI within 30 days of receipt of funds through the Authorised Dealer Bank (AD Bank). The shares have to be allotted within 180 days of receipt of funds. The allotment of shares has to be reported to RBI within 30 days of allotment.

In the month of July every year a report has to be submitted to the Department of Statistics and Information Management (DSIM) about the position of Foreign Investment in the Company.

In the following posts, I will discuss about the specific class of investors, instruments and other detailed instructions.