India's regulatory framework for cross-border financial transactions is governed by multiple overlapping laws, administered primarily by the Reserve Bank of India and other financial authorities. A transaction that looks straightforward commercially can still require clearances or disclosures under several of these regimes at once.
The Regulatory Framework
- Foreign Exchange Management Act, 1999 (FEMA): the cornerstone legislation governing foreign exchange transactions in India, FEMA replaced the earlier Foreign Exchange Regulation Act and is intended to facilitate external trade and payments while supporting the orderly development of the foreign exchange market. The RBI regulates and monitors capital and current account transactions under it, issuing circulars and directions for compliance;
- Prevention of Money Laundering Act, 2002 (PMLA): designed to prevent cross-border transactions from being used for illegal activity such as terror financing or tax evasion. Know Your Customer and Anti-Money Laundering guidelines require financial institutions to carry out due diligence on cross-border flows;
- Regulatory Sandbox Framework: the RBI has introduced a regulatory sandbox to encourage innovation in cross-border payments and fintech, allowing the controlled testing of cross-border payment rails, digital currencies and remittance solutions; and
- Bilateral and multilateral agreements: India enters into agreements with other countries covering taxation, information exchange and cooperation in combating financial crime, which in turn shape how a given cross-border transaction is treated.
Where the Complexity Tends to Arise
Compliance across jurisdictions is the first and most persistent source of difficulty. A transaction may be fully compliant in one jurisdiction and still face regulatory hurdles in another, since foreign exchange, anti-money laundering, tax and remittance rules rarely line up exactly.
Currency exposure is a second recurring issue. Cross-border transactions typically involve more than one currency, and exchange rate volatility can shift the real value of a transaction between signing and settlement, which in turn can lead to disputes over pricing and payment terms.
Double taxation is a third. Differing tax structures between countries, including withholding tax on cross-border payments such as royalties and dividends, can result in the same income being taxed in both the home and host jurisdiction unless a treaty or structuring choice addresses it.
Dispute resolution across jurisdictions adds its own layer of difficulty, since breaches of contract or non-payment disputes have to contend with differing legal systems and differing approaches to enforcing judgments. Sanctions and anti-money laundering compliance is the final recurring theme, since AML regulations differ significantly across countries and businesses must satisfy both the domestic and the international rules that apply to a given flow of funds.
What Non-Compliance Can Cost
Non-compliance with cross-border transaction rules under FEMA can attract a penalty of up to three times the amount involved in the contravention, where that amount is quantifiable, or up to Rs. 2,00,000 where it is not, with a further penalty of up to Rs. 5,000 per day for a continuing violation after the first day.
Given the number of regimes that can apply to a single transaction, structuring and compliance are best addressed before a transaction is executed rather than after a regulator has raised a query.
Disclaimer: The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.