The Liberalized Remittance Scheme ('LRS') established by the Reserve Bank of India ('RBI') facilitates fund remittance by resident individuals for various purposes abroad. This abstract outline key considerations for LRS remitters, including investments in foreign entities, remittance eligibility, family clubbing, documentation requirements, and prohibited transactions. It emphasizes adherence to RBI regulations, providing insights into investment routes, remittance purpose codes, and legal implications. Caution is advised when lending or gifting abroad, with a focus on transparent disclosure. The article concludes by highlighting the significance of using personal funds for remittances, ensuring financial prudence, and maintaining compliance with RBI guidelines for seamless transactions within the LRS framework.
Introduction
LRS is a framework established by the RBI that governs the remittance of funds by resident individuals in India for various purposes abroad. However, several key issues and considerations require the attention of individuals to ensure compliance with the regulations imposed by the RBI. Understanding these key issues, from investments in foreign entities to documentation requirements and prohibited transactions, is crucial for remitters under LRS.
Key Issues
A. Investments in Foreign Entities Abroad
One of the key issues for remitters under LRS is the investment in foreign entities abroad, which is subject to the regulations and directions issued by the RBI under the Overseas Investment ('OI') Regime that consists of the OI Rules, 20221, the OI Regulations, 2022, and the OI Directions, 20222.
Prior to the promulgation of the OI Rules / Regulations, the field was governed by Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 ('TIFS Regulations'). These regulations provided that any resident individual may remit monies abroad for the purpose of setting up a wholly owned subsidiary or joint venture abroad. In other words, the regulations permitted making overseas direct investments in the shares of a foreign company, subject to certain restrictions contained in the regulations (e.g., there should be no round-tripping of funds), and stringent reporting requirements (e.g., filing of Form ODI, and annual filing of Annual Performance Returns). These restrictions were strict and prevented many investors from freely making portfolio investments in companies abroad. At the same time, LRS also permitted the remittance of funds for making investments abroad. The abovementioned restrictions were not applicable to remittances made through the LRS.
Thus, there existed two routes for making investments in the shares of foreign companies – (i) through the ODI route, under the TIFS Regulations, and (ii) through the LRS route, under the LRS scheme. While the LRS scheme provided that while 'setting up' a wholly owned subsidiary or a joint venture, the conditions provided in TIFS Regulations are to be satisfied, it did not require so when an LRS remittance was being made for 'making an investment' in shares of companies abroad. Thus, while the TIFS Regulations and LRS were in force in parallel (i.e., prior to August 2022), it was possible to make investments abroad through the LRS in the shares of foreign companies, without stringent filing and reporting conditions. The only requirement would have been to file Form A2 with the AD bank, with the correct FETERS code specified (e.g., S0001 for making portfolio investments).
Now, in order to remove the above contradiction, the LRS has been amended (Paragraph 6 of the scheme) and any remittances to be made in the shares of any foreign company would have to be made in satisfaction of the OI Rules/Regulations.
B. Who can Remit?
The LRS allows only resident individuals to send money abroad. It is important to clarify that resident individuals cannot remit funds on behalf of a company or partnership firm, even if they hold positions like shareholder, director, or partner. Attempting to find indirect ways to do so would result in non-compliance with regulations. This restriction is rooted in the legal principle captured by the Latin maxim 'Quando aliquid prohibetur ex directo, prohibetur et per obliquum,' which means that what cannot be done directly should also not be done indirectly.
In the case of a sole proprietorship, where the owner and the business are not legally separate entities, the total remittance limit under the LRS remains capped at USD 250,000. This implies that if the owner already remitted USD 250,000 in their individual capacity, they cannot send an additional USD 250,000 on behalf of the sole proprietorship. Moreover, any payments made on behalf of the company, if at all, would create accounting gaps and tax disallowances for the business, as well as legal liabilities for the owner.
C. Clubbing of Remittances within the Family
Since the LRS is 'liberal,' in the literal sense, it provides that the LRS limits (presently capped at USD 250,000 per year) can be consolidated between family members (father, mother, spouse, son, and daughter). This means that a family of 4 persons can remit up to USD 1 million for purposes permitted under LRS.
However, this consolidation/clubbing cannot include a family member, in case of capital account transactions such as opening a bank account or investments, where such a family member is not the co-owner/co-partner of the bank account or investment. This aligns with the LRS principle that the remitter of funds should be the owner of the resulting property or investment. It also aligns with the Prohibition of Benami Property Transactions Act, 1988, and the new OI regime.
D. Documentation and Form A2
For LRS remittances, complying is as simple as submitting Form A2 with basic details as elaborated in the following para. No form is needed for making rupee gifts or loans, but the aggregate of such payments and foreign exchange remitted throughout the year must stay within the LRS limit. Form A2, provided by ADs, acts as proof of remittance, and must be retained by the remitter. The purpose code used in the Foreign Exchange Transaction Electronic Reporting System ('FETERS') under the Foreign Exchange Management Act, 1999 ('FEMA') is vital for accurately classifying the remittance due to varying tax rates applicable for different purposes. To avoid complications and penalties, it is essential to retain Form A2 and promptly provide it when requested by authorities or banks.
The remitter must provide an application cum declaration in Form A2 to the AD or Full-Fledged Money Changer ('FFMC'), including personal and transaction details, purpose, and purpose code for the remittance. Additionally, a declaration of using own funds within the prescribed limit, and using the funds lawfully is required. Quoting the Permanent Account Number ('PAN') is mandatory. Further, the remitter must designate a single branch of an AD for all LRS remittances. If remittances come from different banks, a No Objection Certificate ('NOC') becomes necessary. Capital account transactions require a minimum 12-month banking relationship. ADs cannot lend money for LRS remittances and must maintain records for RBI verification. Non-compliance with these rules may lead to the AD refusing the remittance, but the remitter remains responsible for FEMA compliance.
According to the sunset clause in para 2.4(A) of the RBI's Master Circular3, ADs must keep Form A2 and other foreign exchange sale documents for one year for verification by their Internal Auditors. In cases where no statutory time limit is prescribed for document retention, it is advisable to keep them for a reasonable period.
In situations where Form A2 is lost or misplaced by the remitter or AD, the Supreme Court's ruling in Benga Behera v. Braja Kishore Nanda4 states that the loss of such document must be proved in court, despite diligent search efforts. Only then can secondary evidence, such as a photocopy, be admissible as evidence. Though the Evidence Act, 1872 does not strictly apply to FEMA proceedings, the jurisprudence and principles of evidence law shall be applicable. Hence, if Form A2 is lost at the hands of the AD despite diligent search, other relevant documents, such as a register of sales, monthly summary statement of purchases and sales of foreign currency, LRS declarations, etc., can be used to support the claim.
E. Deviation from Specified Purpose in Form A2
Failure to use remitted funds for the stated purpose in Form A2 could lead to non-compliance under FEMA regulations, resulting in penalties as per s. 10(6) read with s. 13 of FEMA. To avoid legal consequences, it is necessary to utilize the funds strictly for the purposes mentioned in Form A2.
At the time of remittance, individuals must specify the purpose code, allowing remittances for any permitted purpose under the LRS. Contravention of FEMA occurs if foreign exchange acquired for a declared purpose is not used as intended or used for any impermissible purpose. S. 13 outlines penalties, which can be three times the contravention amount if quantifiable or Rs. 2 lakhs if unquantifiable. In the case of a continuing contravention, a penalty of Rs. 5,000 per day may apply. However, using the funds for another permissible purpose does not contravene s. 10(6) of FEMA and avoids penalties under s. 13 thereof.
Nevertheless, it is advisable to inform the bank in writing if there is a change in the intended use after the initial remittance. This precautionary measure helps update the change of use and ensures the correct application of tax collected at source ('TCS') rates based on the revised purpose. Once funds are remitted, they can be used for any permitted purpose under the LRS.5
F. Lending to Relatives Abroad
When considering lending money to non-resident Indian ('NRI') relatives abroad under the LRS, careful consideration is crucial due to the absence of specific restrictions on such transactions. Proper documentation and transparent disclosure of these transactions can help avoid regulatory scrutiny and any unwarranted suspicion.
To make a rupee loan to a close relative of an NRI or Person of Indian Origin ('PIO'), certain conditions must be met. The loan should be interest-free and have a maturity period of at least one year, credited to the Non-Resident Ordinary ('NRO') account of the NRI /PIO's close relative. The loan amount should not be remitted outside India and must be used for personal requirements or business purposes within India. Additionally, the loan amount should not exceed the LRS limit of USD 250,000 per financial year, which reduces the overall LRS limit by the loan amount given. Certain activities, such as investments in Chit Funds, Nidhi Company, agricultural or plantation activities, real estate businesses, or construction of farmhouses, are not allowed for the loan amount. Repayment of the loan should be made through inward remittances or by debiting the borrower's NRO / Non-Resident External ('NRE') / Foreign Currency Non-Resident ('FCNR') account or from the sale of the security against which the loan was granted.
Notably, loans extended to non-NRI relatives or persons not meeting the aforesaid conditions are not permissible under the LRS. Such loans would invite scrutiny from the RBI and other authorities, as they may be considered unauthorized remittances or gifts. If such remittance is made with a wrong purpose code, penalties under the relevant sub-heads of FEMA may be imposed.
G. Gifts to Relatives Abroad
When it comes to gifting money to relatives outside India, similar caution as with lending is required. While the LRS permits gifting, it is essential to follow the prescribed limits and reporting requirements diligently. Overstepping the permissible limits or neglecting reporting obligations may attract regulatory scrutiny and potential penalties.
A new prohibition on gifting OIs to non-residents has been introduced, which might be overlooked by many. As per para 22(4) of the OI Directions, resident individuals are now prohibited from transferring any overseas investment as a 'gift' to a non-resident. This recent change was not in place earlier. As a result, only bank funds, immovable property, and loans acquired under LRS can now be gifted to non-residents. Being cautious while giving gifts to non-residents is essential to ensure compliance with the updated regulations.
H. Prohibited Remittances
Certain remittances are explicitly prohibited under the LRS, and it is important to be aware of these restrictions to avoid legal complications when remitting funds abroad. The following transactions are expressly prohibited under the LRS:
- Transactions specified in Schedule I and II of the Current Account Transactions Rules, which include remittances for lottery tickets, banned magazines, etc.
- Remittances to countries identified by the Financial Action Task Force as non-co-operative countries.
- Remittance for margin trading, which means dealing in derivatives and options.
- Trading in foreign exchange.
I. Source of Money for Remittance
The LRS requires individuals to use their own funds for capital account remittances, as per FEMA regulations. Borrowed funds or bank loans are not allowed for such remittances. However, family members can gift funds to each other and remit them under LRS, which is permissible. Individuals cannot borrow funds in India and remit them abroad for capital account transactions. For instance, using a foreign loan to buy a property abroad is not permitted, even if the loan repayment is within the LRS limit. This restriction has been there since the LRS started, based on the principle of using one's own funds for remittances under the scheme. This principle is mentioned in para 4.2 of the RBI Circular No. 646.
For current account remittances, borrowed funds have always been permitted, even before the LRS. LRS was introduced later as an additional facility, enabling individuals to remit up to USD 25,000 for a capital account, current account, or both. RBI's FAQs dated 13.08.2018 and 06.04.2023 clarify that current account remittances are permitted based on fund-based and non-fund-based facilities from banks.
However, confusion prevails regarding loans from third parties. Before February 2004, certain current account transactions, like travel and gifting, were allowed within limits, with no restriction on the source of funds, whether owned or borrowed. For other current account transactions, there was no limit, and loans could be used for them. With the LRS, only own funds were allowed for remittances under this scheme, but existing facilities for current account transactions still had no restriction on borrowings.
Over time, the LRS has included several other items in its overall limit, such as travel, education, and medical expenses. Therefore, the restriction of using 'own funds' now also applies to current account transactions. However, loans for current account transactions were not prohibited under the initial LRS scheme and seemed unnecessary.
Interestingly, remittances out of lottery winnings, racing, riding, or any other hobby are prohibited under Schedule I of the Current Account Rules. Even if a person has their own funds, income from these prohibited sources cannot be remitted under LRS due to this restriction. This is an important consideration that is often overlooked. The term 'hobby' is broad, and what seems to be prohibited is income from hobbies that involve gambling or chance-based income.
The fungible nature of money poses both a challenge and protection for determining the true source of funds being transferred abroad under the LRS. One has to be aware that money is fungible, meaning that it can be exchanged or replaced by another identical item. For instance, in a given month, a person may have two sources of income – first, salary income of Rs. 1 lakh credited on the 5th day of the month, and second, winnings from the lottery of Rs. 50,000, credited on the 20th day of the month. If such a person wants to transfer Rs. 50,000 abroad on the 21st day of the month, the AD bank may object that the amount is lottery proceeds, which are not allowed under the LRS and the Current Account Transaction Rules. However, such an amount would be allowed because money is fungible and the sequence in which amounts are credited to one's bank account does not matter. The person can claim that the amount is part of their salary income, which is permitted under the LRS.
Conclusion
LRS is essential for every Indian remitter who intends to send funds abroad. The key legal issues and considerations highlighted in this write-up shed light on the complexities and responsibilities that come with using the LRS. As individuals navigate the LRS framework, they must be well-informed about the permissible investments in foreign entities, the eligibility criteria for remittance, and the implications of clubbing remittances within the family. Moreover, understanding the importance of proper documentation, specially Form A2, and strictly adhering to the specified purpose of remittances are crucial to ensure compliance with RBI regulations.
In the pursuit of lending or gifting money to relatives abroad, remitters must exercise caution, follow prescribed limits, and disclose transactions transparently to avoid regulatory scrutiny. It is equally important to be aware of the prohibited remittances and steer clear of engaging in any transactions that contravene the LRS regulations.
Lastly, the principle of using one's own funds for remittances under the LRS underscores the need for responsible financial practices. Borrowed funds should not be utilized for capital account transactions, emphasizing the importance of financial prudence and compliance with the RBI guidelines.
Navigating the LRS landscape can be complex, but it is crucial to remain diligent, seek professional advice when needed, and ensure strict adherence to the regulations set forth by the RBI. By doing so, remitters can engage in seamless and lawful remittances, furthering their financial goals while upholding the integrity of the LRS framework.
Footnotes
1. Ministry of Finance, Department of Economic Affairs, FEM (Overseas Investment) Rules, 2022 (Notification G.S.R. 646(E) dated August 22, 2022, effective from 24.08.2022), https://rbidocs.rbi.org.in/rdocs/content/pdfs/GazetteRules23082022.pdf
2. RBI, FEM (Overseas Investment) Directions, 2022 (Annexed to AP DIR Circular No. 12 dated August 22, 2022), https://files.caclub.in/wp-content/uploads/rbi-notification-dt-22-08-2022-foreign-exchange-management-overseas-investment-directions-2022.pdf
3. RBI, Master Circular on Miscellaneous Remittances from India – Facilities for Residents, Master Circular No.01/2011-12 (2011), https://www.rbi.org.in/commonperson/English/Scripts/Notification.aspx?Id=842#F0
4. (2007) 9 SCC 728
5. Liberalised Remittance Scheme – How Liberal is it? Rashmin Sanghvi & Associates (2023), https://www.rashminsanghvi.com/downloads/foreign_exchange_law/FEMA/LRS_amendments_of_August_2022_April_2023.html
6. RBI, Liberalised Remittance Scheme of USD 25,000 for Resident Individuals, A.P. (DIR Series) Circular No. 64 dated February 4, 2004, https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=1466&Mode=0
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
