INTRODUCTION TO FOREIGN EXCHANGE MANAGEMENT ACT, 1999

BASIC QUESTIONS

1.What is FEMA?

Foreign Exchange Management Act

Explanation

 “Foreign”- any country other than India

“Exchange”- something comes in, something goes out

“Management”- handling of the above mentioned exchange.

Simply stating when there is any exchange between India and any other country such actions are governed by the provisions of FEMA.

2. What is exchanged?

There is an exchange of goods or services and money.

Either as import or export.  The act governs such an exchange of goods/services and money.

3.How the exchange is managed?

The transactions are managed by the governing act FEMA 1999 and its rules and regulations.

4.When does FEMA and its Regulations applicable?

Whenever an exchange takes place as mentioned above, it is  necessary to check the provisions of FEMA.

HISTORY OF THE ACT

India faced trade deficit during the tenure of Indira Gandhi in 1973.

To conserve India’s FOREX resources the Foreign Exchange Regulation Act was passed in 1974.

The purpose of the act was to "regulate certain payments, dealings in foreign exchange and securities, transactions indirectly affecting foreign exchange and the import and export of currency, for the conservation of foreign exchange resources of the country".

FERA proceeded on the presumption that all foreign exchange earned by Indian residents rightfully belonged to the Government of India and had to be collected and surrendered to the Reserve bank of India (RBI). FERA primarily prohibited all transactions, except one’s permitted by RBI.

Introduction of FEMA

FERA was repealed in 1999 and replaced by the Foreign Exchange Management Act, which liberalized foreign exchange controls and restrictions on foreign investment.

FEMA Objective:

FEMA aims at boosting foreign trade and investment more in tune with country's new economic environment of globalization of Indian economy.

To facilitate external trade and payment and promote the orderly development and maintenance of foreign exchange market in India.

Applicability:

This act is applicable to all branches, offices and agencies outside India owned or controlled by a person who is a resident of India.

Difference between FERA and FEMA

Particulars	FERA Act 1974	FEMA Act 1999
PUNISHMENT	It was a criminal offence , punishable with imprisonment as per code of criminal procedure, 1973	Here, the offence is considered to be a civil offence only punishable with some amount of money as a penalty. Imprisonment is prescribed only when one fails to pay the penalty.
QUANTUM OF PENALTY	The monetary penalty payable under FERA, was nearly the five times the amount involved.	Under FEMA the quantum of penalty has been considerably decreased to three times the amount involved
MEANING OF "RESIDENT"	There was a big difference in the definition of "Resident", under FERA, and Income Tax Act	The provision of FEMA, are in consistent with income Tax Act, but a person who is considered to be non-resident under FEMA may not necessarily be a non-resident under the Income Tax Act.

Under FEMA  investments can be classified as:

INBOUND INVESTMENT –investment in India

OUTBOUND INVESTMENT-investment out of India.

With this clarification let’s look into the various regulations and rules applicable.

The Act consists of 49 sections.

currently there are 22 regulations and 5 rules.

Rules in FEMA

• FEM(Adjudication proceedings and appeals)Rules 2000
• FEM(Encashment of Draft, Cheque, Instrument and Payment of Interest ) Rules 2000
• FEM(Authentication of Documents)Rules 2000
• FEM(Compounding Proceedings)Rules 2000
• FEM(Current Account Transaction)Rules 2000

Regulations          

The regulations under FEMA can be classified into

• INBOUND INVESTMENT
• OUTBOUND INVESTMENT
• MISCELLANEOUS

INBOUND INVESTMENT

• FEM(Transfer or Issue of Any Foreign Security) Regulations 2000
• FEM(Acquisition and Transfer of Immovable Property in India) Regulations 2000
• FEM (Establishment in India of Branch Office or Other Place of Business) Regulations. 2000
• FEM (Investment in firm of proprietary concern in India) Regulations, 2000
• FEM (Issue of Security in India by a Branch office or Agency of A Person Resident Outside India) Regulations.2000

 

OUTBOUND INVESTMENT

• FEM(Transfer or Issue of Security by Person Resident Outside India) Regulations 2000
• FEM(Acquisition and Transfer of Immovable Property outside India)Regulations 2000
• FEM(Guarantees)Regulations 2000
• FEM(Foreign Exchange Derivative Contracts)Regulations 2000
• FEM(Insurance)Regulations 2000

MISCELLANEOUS

• FEM(Borrowing or Lending in Foreign Exchange) Regulations 2000
• FEM(Deposit)Regulations 2000
• FEM(Export& Import of Currency) Regulations 2000
• FEM (Realization, repatriation and surrender of foreign exchange) Regulations, 2000
• Foreign Exchange Management (Possession and retention of foreign currency) Regulations, 2000
• FEM(Permissible Capital Account Transaction)Regulations 2000
• Foreign Exchange Management (Remittance of Assets) Regulations, 2000
• FEM(Borrowing and Lending in Rupees)Regulations 2000
• FEM (Foreign Currency Accounts by a person resident in India)regulations 2000
• FEM (Manner of Receipt & Payment)Regulations 2000

RIGHTS ISSUE

Shares confer fractional ownership in the Total Share Capital of the company. Shareholders are owners of the company as they invest their money by way of subscribing to the shares.

Rights issue is a method of raising capital from the existing shareholders of the company.

Rights issue is termed as further issue of share capital that is first offered to the existing shareholders. It is a right conferred upon the members by the statue whenever further issue of shares takes place.

The Section 81(1)(a) of the Companies Act, 1956 confers such right on the existing shareholders.

Timing

Further issue of shares can be made only, after 2 years from the formation of the company or at any time after one year from the 1^st allotment of shares whichever is earlier.

Allotment of shares must be done on a proportionate basis.

Procedure

Offer to be made by Notice specifying the number of shares. Offer period is 15 days.

The shareholders are not under an obligation to accept the shares offered to them.

Rights issue in case of Listed Companies:

When the shares/other securities of a Public Company are listed and traded in a Stock Exchange, practically rights issue cannot be made easily. Reason behind this statement is that, “a person who is a shareholder today may not be a shareholder tomorrow and the shares are freely transferable”.

Hence some other organized and regulated procedure must be followed in case of a Listed Public Company.

In case of a Listed Company, the procedures relating to rights issue are provided in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Definition of “rights issue” – it means an offer of specified securities by a listed issuer to the shareholders of the issuer as on the record date fixed for the said purpose;

The ICDR regulation is applicable for rights issue when the aggregate value of specified securities offered is Rs. 50 lakh or more.

The issure company must appoint one or more Merchant Banker at least one of them must be a Lead Merchant Banker.[1]

Atleast 30 days prior to registering the prospectus or letter of offer with ROC, a draft offer document must be filed with SEBI.  If SEBI asks for any clarification, then the same must be answered and respective changes must be carried out by the issuer company along with the Merchant Banker. The offer document shall contain all the relevant material disclosures which are true and adequate in order to enable investors to take informed decision.

The lead merchant bankers shall exercise due diligence and satisfy himself about all the aspects of the issue including the veracity and adequacy of disclosure in the offer documents.

The company must obtain in-principle approval from the stock exchanges where the specified securities are listed or are proposed to be listed.

• A “RECORD DATE” must be fixed by the Company for determining the shareholders eligible to apply for specified securities proposed to be issued.
• After the announcement of the record date the rights issue cannot be withdrawn.
• If such a withdrawal is proposed, the issuer shall not make an application for listing of any of its specified securities for a period of 12 months from the record date. Exception to such a restriction granted to the shares allotted pursuant to conversion option or exchange of convertible securities allotted prior to the record date.
• A “RESTRICTION” has been imposed on the company if it has outstanding fully/partly compulsorily convertible debt instruments at the time of making rights issue. In such a case, the issuer must have a made a reservation of the same class of equity shares in favor of the holders of the debt instruments in such convertible proportion.
• The equity shares so issued to the holders of such debt instruments shall be issued on the same terms as the equity shares.
• The issuer company has to issue an “ABRIDGED LETTER OF OFFER” + application form to all the existing shareholders 3 days before the date of opening of the issue through registered post or speed post.
• Shareholders who do not receive the application form can get the same by APPLYING IN PLAIN PAPER along with the application money.
• The ISSUE PRICE must be decided before the record date which will be determined in consultation with the designated Stock Exchange.
• The rights issue will be open for subscription for period of 15 days to 30 days.

• Pre-issue advertisement must be made in at least one English national daily, one Hindi national daily, and one regional language atlease 3 days before the date of opening of the issue.
• The pre-issue advertisement will contain,

1.      The date of dispatch of the abridged letter of offer+ application form.

2.      Centers were the shareholders can receive the application form in case they don’t receive them.

3.      A statement that shareholders may apply in plain paper for rights shares if have not received the application form or they are unable to obtain the duplicate forms.

4.      Format for applying the rights shares.

5.      A statement that the applications can be directly sent through registered post along with the application money to the address mentioned in the advertisement.

• The issuer may make reservation for its employees along with the rights issue such that the allotment shall not exceed Rs. 2 Lakhs.
• Once the basis of allotment is finalized the issuer shall utilize the funds of rights issue.

Further issue in case of Private companies and Unlisted Companies:

Board meeting must be convened and notice must be approved and dispatched to the members of the company. At the expiry of the offer period of 15 days, the accepted shares must be allotted to the respective shareholders by convening a Board Meeting.  E-form 2 must be filed with the Registrar of Companies (ROC) intimating the allotment of shares.

These are the procedures to be followed while raising capital by way of rights issue. The details given above are simplified for the understanding of the students. The text of the full regulation is available at www.sebi.gov.in

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[1] Merchant Bankers are intermediaries in the process of public issue of securities. They are Companies registered under Companies Act as well as registered with SEBI as an intermediary.

RELATED PARTY TRANSACTIONS

Related party transactions are those where two parties who share some common benefit in carrying out a particular transaction. This article will provide the definition, provisions and restrictions contained in Companies Act, Income Tax Act and Accounting Standards.

 The provisions, guiding the related party transactions are available under Section 297 of the Companies Act, 1956.

The Companies act does not define the term “related party” instead, it mentions the term “interest”.

The act restricts the contracts to be entered by the company with related parties. The company without the consent of the board cannot enter into contracts with a Private company or a firm where any directors/ relative of a director are interested in any way as a Director/partner/member of such private company. The following are the transactions:

1.      For sale or purchase or supply of goods and services

2.      For underwriting or subscribing to shares or debentures of the company.

So the contracting party should not be a PRIVATE COMPANY or a FIRM where directors are interested. And if the company has a paid up share capital of Rs. 1 crore or more it should get the approval of Central Government. 

If such a transaction is at prevailing market price or if the value of such a transaction is up to Rs. 5000 in aggregate in any year for the period comprised in the contract, the approval of the Central Government is not required.

In case of urgent necessity such contracts can be entered by the company without getting the approval of the board and within 3 months of entering into contract, the board’s approval should have been received.

For the purpose of related party transactions, the resolution of the board must be obtained “AT THE MEETING” and not by way of circular resolution.

Practical Procedure:[1]

Prior notice of the contract must be sent to the board members along with the agenda of the meeting.

During the board meeting, while considering the transaction, the interested director must stay away from the proceedings for that particular resolution.

What if?

If the consent of the board is not obtained to any contract then, anything done in pursuance of the contract shall be void at the option of the board.

Registers to be maintained:

Register under Section 301 - the provisions of this section mandates, the maintenance of a register detailing the contracts entered into by the company with the related parties. The same register must be placed at the meeting of the board.

Section 301(3) – register relating to the companies or firms in which directors are interested. This register must be entered with the details provided by the directors in Form 24AA as per Section 299(3).

“The intention of these provisions is to keep a check on the directors in carrying out the business of the company in their favor.

The act specifically restricts the transactions to be entered with a private company, as in most private companies the directors and members are one and the same.”

The Income tax Act disallows the expenditure incurred in respect of Related Parties, if in the opinion of the Assessing officer, the expenditure is excessive and unreasonable.

These expenditures are (a) the fair market value of goods, services or facilities for which the payment is made or persons (Related Parties) or (b) legitimate needs of business or profession of the assessee or (c) the benefit derived by or accruing to the assessee from the payment.

Income Tax act defines the following persons as a related party under section 40A (2)(b)

 (i) Where the assessee is any relative of the assessee; individual

(ii) Where the assessee is a any director of the company, company, firm, association partner of the firm, or member of of persons or Hindu undivided the association or family, or any family relative of such director, partner or member;

(iii) Any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;

(iv) A company, firm, association of persons or Hindu undivided family having substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member;

(v) A company, firm, association of persons or Hindu undivided family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;

(vi) Any person who carries on a business or profession, - (A) Where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or

(B) Where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner, or member, has a substantial interest in the business or profession of that person.

Explanation: For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if - (a) In a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; and

(b) In any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession. “

“So, the probability of being taxed for such a related party transaction is in the opinion of the Assessing Officer. “

The Accounting Standard 18 (AS 18) issued by the ICAI, has the following provisions to be complied with respect to related party transactions. They must be disclosed by Companies in their financial statements.

[2]Definitions of various terms:

Related party - parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions.

Related party transaction - a transfer of resources or obligations between related parties, regardless of whether or not a price is charged.

 Control – (a) ownership, directly or indirectly, of more than one half of the voting power of an enterprise, or (b) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise, or (c) a substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise.

 Significant influence - participation in the financial and/or operating policy decisions of an enterprise, but not control of those policies.

 An Associate - an enterprise in which an investing reporting party has significant influence and which is neither a subsidiary nor a joint venture of that party.

A Joint venture - a contractual arrangement whereby two or more parties undertake an economic activity which is subject to joint control.

Joint control - the contractually agreed sharing of power to govern the financial and operating policies of an economic activity so as to obtain benefits from it.

Key management personnel - those persons who have the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise.

 Relative – in relation to an individual, means the spouse, son, daughter, brother, sister, father and mother who may be expected to influence, or be influenced by, that individual in his/her dealings with the reporting enterprise.

Holding company - a company having one or more subsidiaries.

Subsidiary - a company:

(a) in which another company (the holding company) holds, either by itself and/or through one or more subsidiaries, more than one-half in nominal value of its equity share capital; or

(b) of which another company (the holding company) controls, either by itself and/or through one or more subsidiaries, the composition of its board of directors.

Fellow subsidiary - a company is considered to be a fellow subsidiary of another company if both are subsidiaries of the same holding company.

State-controlled enterprise - an enterprise which is under the control of the Central Government and/or any State Government(s).

The standard describes the related parties as:-

1.      Enterprises that are directly or indirectly controlled by the reporting enterprise.

2.      Associate company or Joint venture and the investing party or venturer of the reporting enterprise.

3.      Individuals having a direct or indirect voting power in the reporting enterprise and relatives of such individuals.

4.      Key Management Personnel and their relatives

5.      Those enterprises where the persons mentioned in (4) & (5) have a significant influence and enterprises having common key managerial personnel.

The related party disclosures as defined in the accounting standard are not applicable when such disclosures would conflict with the reporting enterprise’s duty of confidentiality.

The term substantial interest means owning directly or indirectly 20% or more of the voting power of the reporting enterprise.

This standard requires that even if no transactions are carried out during a financial year, the relationship must be disclosed in the financial statements.

Spirit of this standard:

When there is no beneficial relation between two parties in a transaction, it is assumed that the transactions are carried out in an Arm’s Length Price. But when there exist any interest between the parties, the transactions might be charged at a price which is beneficial to them.  The resulting accounting measures may not represent what they usually would be expected to represent.

“These are the various provisions, to be complied, under various statutes with respect to related party transactions by a Company.” The Accounting Standard includes various parties as related to the company, while Companies Act requires the approval of Board of Directors or Central Government in certain cases. But under the Income Tax act, the power of taxation is with the Assessing officer, who must be satisfied in allowing the expenses carried out for the related party transactions.”

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[1] Source: on discussion with a Company Secretary of a listed company during one of my Secretarial Audit.

Refer section 300

[2] Source : Original text of accounting standard 18

ROLE OF PROFESSIONALS -AUDITORS

The Companies Act 1956, lists out the role of professionals such as Chartered Accountants, Company Secretaries and Cost Accountant

This article will give you the activities, duties and responsibilities of these professionals in dealing with the affairs of a Company.

Auditors (section 224 to 233B)

Who is an auditor?

An auditor is a person who possess extensive knowledge, expertise and requisite qualification for auditing the financial affairs of the company and does not have any pecuniary relationship with the company and who gives a true and fair view of the affairs of the company for the benefit of the stakeholders.

Section 226 of the act details the qualifications for an auditor.

v    A person who is a chartered accountant as defined in “The Chartered Accountants act of 1949”

v    No Body corporate or company should be appointed as auditor of the company.

v   The auditor who has been disqualified by virtue of any of the provisions of this section should not be appointed as auditor for the holding or subsidiary companies also.

How an Auditor is appointed?

Generally, an auditor/s is appointed at the Annual General meeting of the company to hold office from the conclusion of the AGM until the conclusion of the next AGM.

He should intimate his appointment to the ROC in e-form 23B within 30 days of his appointment.

The first auditor of a company should be appointed by the board of directors within one month of registration of the company and the first auditor holds office until the conclusion of the First AGM.

Members have the right to remove the first auditors of the company in the annual general meeting. Any member can nominate a person or persons as auditors of the company and such nomination notice must be given 14 days before the date of the AGM.

It is evident that, the auditor is answerable to the members/ investors of the company.

What is the limit in number of companies acting as a Auditor?

An individual auditor or a firm can act as auditor for 20 companies, each of which has a paid up capital of less than Rs. 25 lacs

In any other case, they can act as auditor of 20 companies out of which not more than 10 companies should have a paid up capital of Rs. 25 lacs or more.

In case of a company other than a private company, no board or company should appoint any person who is in the full time employment elsewhere, as auditor of the company if he exceeds the specified number of companies.

Any person - in case of firm of auditors, the specified number of companies will be construed as the number of companies specified for every partner.

Can the retiring auditor be reappointed?

Subject to complying with the provisions of acting as auditor of specified number of companies, A retiring auditor can be reappointed unless

©      He is disqualified for re-appointment

©      He has given his unwillingness to be re-appointed

©      A resolution has been passed not to appoint him as auditor

©      By reason of death or incapacity or the resolution cannot be proceeded with.

How is casual vacancy filled?

The resignation of auditors must be filled by the members in general meeting. All other casual vacancies in the office of auditors can be filled by the board of directors.

Auditor appointed in casual vacancy can hold office up to the conclusion of next annual general meeting.

How can auditor be removed?

The power to remove auditor who is appointed in general meeting lies with the members and it requires prior approval of central government.

Brief about the Remuneration of auditors

The remuneration to the auditor is determined by the board of directors/ members / central government who appoints the auditor.

“The provisions relating to auditors give a wider power to the members of the company than to the board of directors. This is because the auditors are responsible for projecting the actual state of affairs of the company and they have a bounded duty to give a fair view about the business to its investors.”

Special notice for appointment of auditors:

The appointment of any other person other than the retiring auditor requires a special notice to be attached with the AGM notice. This special notice is required even in the case of removing an auditor.

The act confers a power on the retiring auditors to give his representation about the company. This representation must be sent to the members along with the notice of AGM or a fact must be stated in the notice that such a representation is received by the company from the Auditors. The officers who are responsible for sending notice of AGM should take the responsibility for sending this representation.

The auditor might ask for the same representation to be read out at the meeting.

If anybody feels aggrieved by such representation, they can apply to the Central Government to prevent from the circulation of such representation or reading out at the AGM and if the CG approves, the auditor may have to bear the entire cost of such expenses.

“This is a power conferred upon the auditor and a kind of duty on the auditor to give out his representation about the company. “ This power can be exercised by the first auditor, auditor appointed by members and also by a retiring auditor who is specifically prohibited from re-appointment.”

Brief about the Auditors report:

Section 227 talks about the Auditors report.

It should detail about the functions of the company, the way the funds are utilized, the mandatory compliances carried out by the company etc,.

The auditor’s report must be signed by the Auditor of the company; in case of firm of auditors the person who represents the firm must sign the report.

The auditor has a right to get the notices of AGM and they have a right to attend the Annual general meeting of the company.

“This requires the Auditors to give an unbiased report about the financial affairs of the company. It imposes a duty on the auditor to bring out any qualifications or adverse remarks on the affairs of the company.”

From the provisions of Companies Act, it is clear that the role of auditor is not simply confined with the reporting of the affairs of the company, rather involves a responsibility of projecting the misdeeds and frauds involved in the activities of the company.  

The report of the auditor has a greater significance in knowing about the company and is not simply a report to be complied as per the act but it is a weapon in the hands of investors.