FEMA Compliance and Legal Issues in Foreign Exchange Transactions

Foreign exchange transactions represent critical business operations for Indian companies engaged in international trade, investment, and finance. These transactions are governed by the Foreign Exchange Management Act (FEMA), 1999 through a complex regulatory framework that general counsels must navigate with precision. Non-compliance carries significant financial penalties and reputational risks that can impact shareholder value and operational continuity.

The FEMA Regulatory Landscape in 2025-26

The Reserve Bank of India (RBI), as the country’s financial regulator, administers FEMA and distinguishes between current account and capital account transactions. This distinction fundamentally determines permissibility, approval requirements, and compliance obligations. The regulatory framework continues to evolve through RBI notifications and circulars that modify permissible transaction categories and introduce new compliance requirements.

In 2025-26, the regulatory focus has intensified on beneficial ownership disclosure, round-tripping prevention, and transaction documentation. The RBI has enhanced monitoring mechanisms for foreign investment flows, particularly from countries sharing land borders with India, requiring prior government approval for such investments beyond specified thresholds.

CEOs and MDs must recognize that FEMA compliance is not merely a legal checkbox but a strategic imperative affecting access to international capital, credibility with foreign partners, and operational flexibility in global markets. The liberalization trajectory has opened opportunities while simultaneously demanding more sophisticated compliance infrastructure.

Current Account Transactions: Liberalization with Limits

Current account transactions involve trade in goods and services, transfers for living expenses, and moderate value remittances. These transactions generally enjoy automatic approval without individual RBI permission, operating within regulatory frameworks established through regulations and master directions.

However, liberalization has boundaries. The Liberalized Remittance Scheme (LRS) allows resident individuals to remit up to USD 250,000 per financial year for permitted transactions. This limit, unchanged in recent years, requires general counsels to structure larger transactions through alternative compliant mechanisms when business needs exceed these thresholds. Although Budget 2025 revised the LRS scheme with a higher Tax Collected at Source (TCS) free threshold from Rs. 7 Lakhs to Rs. 10 Lakhs for certain eligible purposes, making global financial transactions easier.

Import payments require careful documentation compliance. Advance remittances for imports demand bank guarantees or compliance with guidelines under the Foreign Trade Policy. Non-compliance with import documentation requirements triggers enforcement action, including penalties and potential criminal liability under FEMA provisions.

Export proceeds realization represents a critical compliance area. Exporters must realize and repatriate export proceeds within specified timelines, earlier it was nine months from shipment dates which has been extended to 15 months as per notification no. FEMA 23(R)/(7)/2025-RB (13.11.2025) unless further extended by RBI or through GR/SDF form mechanisms. Delays in realization require explanation and potentially regulatory approval, making working capital management and international credit terms subject to FEMA constraints.

Capital Account Transactions: FDI and ODI Frameworks

Foreign Direct Investment (FDI) into India operates through either automatic route or approval route depending on sectoral caps and conditions. The FDI Policy, revised periodically, specifies permissible sectors, investment limits, and entry conditions. In 2025-26, defense, insurance, and certain other sectors remain subject to government approval beyond specified thresholds. However, the FDI limit in the insurance sector was increased to 100% in the Union Budget 2025-26, subject to specific conditions

The press note system and consolidated FDI policy circulars create layered compliance requirements. General counsels must verify that proposed foreign investment structures comply with sectoral caps, meet minimum capitalization requirements where applicable, and satisfy pricing guidelines under FEMA regulations. Downstream investments by entities receiving foreign investment also face restrictions requiring careful structuring.

Overseas Direct Investment (ODI) by Indian entities is governed by the Overseas Investment Rules, 2022. This framework allows Indian entities to make financial investment up to 400% of net worth under automatic route for specified activities. Financial services ODI faces additional scrutiny and lower automatic route limits. The requirement for periodic reporting through ODI returns and compliance certificates creates ongoing obligations beyond initial transaction approval.

Round-tripping concerns have prompted enhanced regulatory scrutiny. The RBI examines whether apparent foreign investments actually represent disguised domestic funds routed through offshore structures to access preferential treatment or circumvent regulations. Structures involving tax havens or opaque ownership chains face heightened examination and potential rejection.

Foreign Portfolio Investment Compliance

Foreign Portfolio Investors (FPIs) operate under a separate regulatory framework administered jointly by RBI and Securities and Exchange Board of India (SEBI). FPI registration categories, investment limits in listed entities, and aggregate limit monitoring require coordination between issuers, depositories, and regulators.

Recent years have seen a continued focus on beneficial owner identification for FPIs. Enhanced know-your-customer norms require disclosure of ultimate beneficial owners controlling FPI structures, closing loopholes that previously allowed non-transparent participation in Indian markets. General counsels advising companies on FPI investment should ensure investors meet enhanced transparency standards.

Voluntary retention routes and government securities investment by FPIs have expanded, reflecting broader market liberalization. However, investment limits in debt securities and sectoral caps in equity investments require monitoring to prevent inadvertent violations affecting both FPIs and issuer companies.

External Commercial Borrowings: Opportunity and Risk

External Commercial Borrowings (ECB) provides access to international capital markets for Indian corporates. The ECB framework specifies eligible borrowers, recognized lenders, permissible end-uses, and all-in-cost ceilings based on maturity periods. As per current RBI frameword, the automatic route ECB limit stands at USD 750 million per financial year for eligible borrowers, subject to compliance with framework conditions.

However, the RBI has proposed a major liberalization of the ECB regime for 2025–26, including a substantial enhancement of borrowing limits to the higher of USD 1 billion or 300% of the borrower’s net worth, signaling a shift toward greater access to foreign capital.

Traditional end-use restrictions prohibit ECB utilization for real estate, capital market investment, and working capital for specified purposes. Violations attract significant penalties and potential criminal prosecution. CFOs and general counsels must establish robust internal controls ensuring ECB proceeds are deployed only for approved purposes with documentary evidence supporting compliant utilization.

Hedging requirements for ECB have evolved. While comprehensive hedging is not mandatory for all ECB, borrowers must have board-approved risk management policies addressing foreign exchange exposure. The 2024 revisions to hedging guidelines provided flexibility while maintaining the expectation that companies manage currency risk prudently.

Trade Credits and Supply Chain Financing

Trade credits for imports up to specific tenors enjoy liberalized treatment under FEMA. Beyond these tenors, transactions constitute ECB requiring compliance with the ECB framework. This distinction proves critical for CFOs managing supplier payment terms and companies structuring supply chain finance arrangements.

The rise of supply chain financing platforms creates FEMA compliance questions. When foreign entities finance Indian importers or exporters through platform mechanisms, transactions must comply with either trade credit provisions or ECB framework depending on transaction structure and tenor. Innovative financing structures require careful legal analysis to ensure FEMA compliance.

Export credit from overseas branches and subsidiaries of Indian banks to third-party exporters has specific provisions. These arrangements must comply with interest rate provisions and reporting requirements distinct from general ECB or trade credit rules, demanding familiarity with specialized regulatory provisions.

Enforcement and Penalty Framework

FEMA violations attract significant penalties. Contraventions can result in penalties up to three times the sum involved or up to Rs 2 lakh when amounts are not quantifiable. The Enforcement Directorate investigates serious violations, with adjudication by Special Directors and appeals to Appellate Tribunal for Foreign Exchange.

Recent years have witnessed increased enforcement action targeting non-compliance with reporting requirements, end-use violations in ECB, and irregularities in FDI structures. High-profile cases involving major corporates underscore that size provides no immunity from enforcement when violations occur.

Beyond financial penalties, FEMA violations can trigger reputational damage affecting foreign investor confidence, banking relationships, and regulatory standing with SEBI and other authorities. For listed companies, enforcement proceedings can impact stock prices and create disclosure obligations under listing regulations.

Compounding and Regulatory Settlement

FEMA provides compounding mechanisms allowing violators to settle contraventions by paying compounding fees. While compounding doesn’t constitute prosecution or conviction, it requires admission of violation and payment of compounding charges determined by compounding authorities based on nature and amount of the contravention.

The compounding process has become more transparent with published compounding order summaries providing guidance on fee calculation methodologies. However, compounding doesn’t guarantee immunity from future consequences, as compounded violations remain on regulatory records and can influence future application approvals.

Strategic decisions around voluntary disclosure versus awaiting enforcement action require careful cost-benefit analysis. Early disclosure and voluntary compounding often result in lower financial impact compared to penalties imposed after enforcement proceedings, but disclosure itself confirms violation occurrence.

FEMA (Export and Import of Goods and Services) Regulations, 2026

A significant development shaping the foreign trade and FEMA compliance landscape for 2025–26 is the Reserve Bank of India’s notification of the Foreign Exchange Management (Export and Import of Goods and Services) Regulations, 2026 (Notification No. FEMA 23(R)/2026-RB dated 13 January 2026), which will come into force from 1 October 2026. These Regulations comprehensively supersede the Foreign Exchange Management (Export of Goods and Services) Regulations, 2015, consolidating a previously fragmented regime of circulars, instructions, and operational guidelines into a single, unified statutory framework governing both exports and imports of goods and services, including software. A key reform under the new regime is the introduction of a unified Export Declaration Form (EDF) applicable to both goods and services, supported by electronic filing and clearly defined timelines, thereby significantly simplifying export declarations and procedural compliance.

Substantively, the Regulations codify uniform timelines for realisation and repatriation of export proceeds, generally prescribing 15 months, extendable to 18 months where exports are invoiced or settled in Indian Rupees (INR), with discretionary extensions vested in Authorised Dealer (AD) banks. The framework also formally regulates advance payments, delayed import payments, set-off of export receivables against import payables, third-party receipts and payments, merchanting trade transactions, project exports, and international trade invoicing and settlement in INR, aligning FEMA compliance with modern trade practices. Crucially, the role of Authorised Dealers is significantly enhanced, with mandatory requirements to maintain robust internal policies and Standard Operating Procedures (SOPs), conduct transaction-level monitoring, and ensure comprehensive reporting through EDPMS, IDPMS and FETERS, thereby strengthening transparency, traceability, and regulatory oversight across cross-border trade transactions.