How to comply with FEMA for foreign investments

Understanding the Liberalised Remittance Scheme (LRS)

The main framework you need to know is the Liberalised Remittance Scheme (LRS). This scheme, managed by the Reserve Bank of India (RBI), allows resident Indians to send a certain amount of money abroad each financial year. The current LRS limit is 250,000 US dollars per person.

This limit is not just for investments. It covers a wide range of purposes, including:

• Travel expenses
• Education fees
• Medical treatment
• Gifts or donations
• Investing in stocks and property

Every rupee you send abroad for these purposes counts towards your annual LRS limit. It is your responsibility to track all your remittances to ensure you do not cross this threshold.

A Step-by-Step Guide to Complying with FEMA Rules for Indian Investors

Following the rules is straightforward if you break it down into steps. Here’s how you can make your foreign investment journey smooth and compliant.

Step 1: Confirm Your Resident Status

FEMA rules for foreign investments apply specifically to ‘persons resident in India’. According to the act, you are a resident if you have lived in India for more than 182 days during the preceding financial year. If you meet this condition, you can use the LRS facility. Non-resident Indians (NRIs) have different rules and cannot use the LRS.

Step 2: Choose an Authorised Dealer (AD) Bank

You cannot send money abroad through just any channel. All foreign remittances under LRS must be processed through an Authorised Dealer (AD) Bank. Most major public and private sector banks in India are ADs. Your bank will guide you through the process, handle the currency conversion, and report the transaction to the RBI, which is a regulatory requirement.

Step 3: Submit the Necessary Forms

The paperwork is simpler than it sounds. You will need to submit two main documents to your AD Bank:

1. Form A2: This is a simple application form for purchasing foreign exchange. You will fill in your details, the amount you want to send, the currency, and the purpose of the remittance.
2. LRS Declaration: This is a straightforward declaration where you state the purpose of sending money and confirm that the total amount you have sent this year, including this transaction, is within the 250,000 dollar limit.

You will also need to provide your Permanent Account Number (PAN), as it is mandatory for all LRS transactions.

Step 4: Know the Permissible Investments

Under the LRS, you have many options for international investing. Permissible investments include:

• Buying shares of listed foreign companies.
• Investing in international mutual funds or Exchange Traded Funds (ETFs).
• Acquiring immovable property abroad.
• Opening and maintaining a foreign currency bank account.
• Investing in debt instruments like bonds.

However, there are restrictions. The scheme does not permit remittances for trading on the foreign exchange market, investing in certain derivatives, or sending money to countries identified as non-cooperative by the Financial Action Task Force (FATF).

Step 5: Account for Tax Collected at Source (TCS)

When you send money abroad under LRS, a tax is collected at the source by your bank. This is called TCS. For investments, a 20% TCS is applicable on any amount you send above a threshold of 7 lakh rupees in a financial year.

For example, if you send 10 lakh rupees for foreign investment, TCS will not apply to the first 7 lakh rupees. It will apply to the remaining 3 lakh rupees. The tax would be 20% of 3 lakh rupees, which is 60,000 rupees.

This is not an extra tax on you. You can claim this TCS amount as a credit when you file your annual income tax return.

Common Mistakes to Avoid

Even with the best intentions, investors can make mistakes. Here are a few common pitfalls to watch out for.

Exceeding the LRS Limit

Carefully track all your foreign remittances throughout the financial year (April to March). Exceeding the 250,000 dollar limit without special permission from the RBI can lead to penalties. Remember to include all remittances, not just investments.

Using an Incorrect Purpose Code

On Form A2, you must specify a purpose code for your remittance. For buying foreign stocks, the code is typically ‘S0001’. Using the wrong code can lead to incorrect reporting to the RBI and may cause issues later. Always double-check with your bank if you are unsure.

Forgetting to Disclose Foreign Assets in Your ITR

This is a big one. Complying with FEMA is only half the battle. You must also declare all your foreign assets—including stocks, mutual funds, and bank accounts—in your Income Tax Return (ITR). Failure to do so can result in severe penalties under the Black Money Act.

Remember, FEMA compliance is about the transfer of money, while ITR filing is about declaring your assets and income to the tax authorities. You must do both.

Tips for a Smooth Investment Process

Keep these tips in mind to make your global investing experience hassle-free.

• Maintain Good Records: Keep a file with copies of your Form A2, bank statements showing the remittance, and purchase confirmations from your foreign broker.
• Consult an Expert: If you are investing a significant amount or feel confused, talk to a chartered accountant or a financial advisor who specializes in foreign investments.
• Stay Updated: Rules can change. Occasionally check the RBI website for any updates to the LRS or FEMA regulations. You can find useful information in their public communications. For more details, you can review the RBI's FAQs on LRS.
• Start Small: If you are new to this, start with a small investment to understand the process. You can always invest more as you become more comfortable.