Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017

The Foreign Exchange Management Act (FEMA), 1999, governs foreign exchange transactions in India. In 2017, the Reserve Bank of India (RBI) issued a specific set of rulesForeign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (hereafter the 2017 Regulations). These Regulations address the issuance and transfer of securities by nonresident Indians (NRIs) and other persons residing outside India, especially when the securities are linked to Indian assets or Indian entities.

1. Why the Regulations Were Introduced

Prior to 2017, the legal framework for crossborder issuance of securities was fragmented, creating uncertainty for investors, issuers, and intermediaries. Key reasons for the new rules were:

• Clarity on permissible transactions distinguishing between permitted and prohibited issues or transfers.
• Alignment with international standards ensuring Indian markets remain attractive to foreign investors.
• Risk mitigation preventing illicit capital flows, moneylaundering and tax evasion.
• Facilitation of capital market development encouraging greater participation of the Indian diaspora.

2. Scope of the Regulations

The Regulations apply when a person resident outside India (PRO) intends to:

• Issue a security (equity, debt, convertible instruments, etc.) that is linked to an Indian asset, business, or entity.
• Transfer an existing security that was originally issued by an Indian entity.

They do **not** apply to securities that are wholly foreign in nature and have no connection with Indian assets or Indian issuers.

3. Key Definitions

Understanding a few core terms is essential:

• Person Resident Outside India (PRO): Any individual or entity that is a nonresident under the Income Tax Act, 1961, and resides outside the territory of India.
• Security: Includes shares, debentures, bonds, warrants, convertible instruments, and any instrument that confers a right to receive payment or ownership in an Indian entity.
• Issue: The creation, allotment, or offering of a security to the public or a select group of investors.
• Transfer: Sale, assignment, or any other conveyance of ownership rights in a security.

4. Permissible Activities

The Regulations enumerate activities that a PRO may lawfully undertake, subject to compliance:

• Issue of securities A PRO can issue shares, debentures, or convertible instruments of an Indian company, provided the issue is authorized by the companys board, and the issue complies with the Companies Act, 2013 and SEBI regulations.
• Transfer of securities A PRO may sell or otherwise transfer Indian securities held abroad, subject to RBI approval where required.
• Holding securities Securities can be held in offshore accounts, but the underlying asset must be appropriately vest in an Indian entity.
• Repurchase An Indian company may repurchase its own securities from a PRO, subject to the same approvals as a fresh issue.

5. Prohibited Activities

The Regulations place clear limits on what a PRO cannot do without specific RBI permission:

• Issuing securities that would result in the creation of a direct or indirect interest in an Indian business without prior RBI approval.
• Transfer of securities that are pledged or encumbered without the consent of the mortgagee or pledgee.
• Any activity that contravenes the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, or other applicable legislation such as the SEBI (Issue of Capital & Disclosure) Regulations.

6. Procedural Requirements

6.1 Prior Approval

In most cases, the PRO must obtain a prior approval from the RBI before the issue or transfer. The application is made through the RBIs Foreign Exchange Online (FEO) portal and must include:

• Details of the security (type, amount, pricing).
• Identity and KYC documentation of the PRO.
• Board resolution of the Indian issuer authorizing the issue/transfer.
• Compliance certificates from auditors or legal counsel.

6.2 Reporting Obligations

After the transaction, the Indian entity or the PRO must file a return with the RBI within 30 days, providing:

• Copy of the issue/transfer agreement.
• Evidence of receipt of funds (if any) in a designated bank account.
• Details of the securities held by the PRO.

6.3 Documentation

Key documents include:

• Form A2 Application for approval.
• Form FRC Return of issue/transfer.
• Board resolution and shareholder approval (where required).
• Declaration that the securities will not be used for moneylaundering or financing of prohibited activities.

7. Role of Intermediaries

Authorized banks, depositories, and brokers play a vital role:

• Authorized Dealer Banks (ADBs) act as the conduit for the inflow/outflow of funds and file the necessary RBI returns.
• Depositories (NSDL/CDSL) maintain the electronic records of securities held by PROs, facilitating smooth transfer and settlement.
• International Custodians can hold Indian securities on behalf of foreign investors, subject to RBI clearance.

8. Tax Implications

While the Regulations themselves are not tax law, compliance intersects with tax considerations:

• Dividends received by a PRO are subject to withholding tax under Section 195 of the Income Tax Act.
• Capital gains on the sale of Indian securities by a PRO are taxable in India if the asset is classified as a "situs of source" asset.
• Double Taxation Avoidance Agreements (DTAAs) between India and the PROs residence country may provide relief.

9. Penalties for NonCompliance

Violations can attract both civil and criminal penalties:

• Monetary fines up to INR5crore or the value of the transaction, whichever is higher.
• Direction to reverse the transaction.
• Prosecution under the FEMA provisions, which may lead to imprisonment for up to three years.

Repeated violations can result in the RBI revoking an entitys authorisation to deal in foreign exchange.

10. Recent Developments (20232024)

Since 2017, the RBI has issued clarifications:

• Expanded the definition of security to include digital tokens that represent equity in an Indian company, provided the token is issued on a recognised platform.
• Introduced a streamlined selfcertification route for certain smallscale issues, reducing the need for full RBI approval.
• Issued guidance on the treatment of securities issued by Indian startups to diaspora investors under the Startup India scheme.

11. Practical Steps for Companies and Investors

1. Assess Eligibility Verify whether the security and the intended transaction fall within the scope of the 2017 Regulations.
2. Obtain Board Approval Secure a board resolution authorising the issue/transfer.
3. Engage an Authorized Dealer Choose an RBIapproved bank to act as the conduit and file the application.
4. Prepare Documentation Compile KYC, legal opinions, and the necessary RBI forms.
5. Submit Application via FEO Provide all information in the prescribed format and wait for RBI sanction.
6. Complete Transaction Upon approval, execute the issue/transfer, ensuring funds are routed through the designated bank.
7. File PostTransaction Returns Submit Form FRC and any supporting documents within the stipulated time.
8. Maintain Records Keep all transaction records for at least five years for audit and tax purposes.

12. Conclusion

The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, provide a comprehensive framework that balances the need for capital market openness with the imperative of regulatory oversight. By clearly delineating permissible activities, establishing a transparent approval process, and aligning with broader FEMA and SEBI requirements, the Regulations have made it easier for NRIs and other foreign investors to partake in Indian securities while safeguarding the integrity of the financial system.

For detailed guidance, stakeholders should consult the RBI circulars, the latest FEMA handbook, and, where necessary, seek advice from legal and tax professionals specialising in crossborder securities.

For further reading, visit the Reserve Bank of India website or the Securities and Exchange Board of India portal.