PROGRESSION OF

FOREIGN EXCHANGE REGULATION ACT 1973

TO

FOREIGN EXCHANGE MANAGEMENT ACT 1999

&

It’s IMPACT ON FOREX

INCLUDEPICTURE "http://image2.mouthshut.com/images/imagesp/l/Mumbai-Educational-Trust-

Bombay-925043728s.jpg" \* MERGEFORMATINET

Prepared by:

Roll No. Names81 Namita Rane83 Amit A. Kilpady85 Kalpak P. Malankar87 Pooja Paralikar89 Poonam Pawar 91 Darshan Purohit93 Ronney Rodrigues95 Sanjam Sahni97 Chintan Shah99 Nirali Shah

INDEX

Sr. No. Topics Page No.

1 Introduction 3

2

Need to Introduce Foreign

Exchange Regulation Act

(FERA) 4

3 FERA, 1973 5

Definition 6

Contravention and Penalties 10

4

Need to Introduce Foreign

Exchange Management Act

(FEMA) 11

5 FEMA, 1999 14

Highlights 14

Recent Amendments 15

Contraventions and

Penalties 19

6 FERA Vs FEMA 20

7

Pre-Shipment and Post-

Shipment Credit 25

8

Impact of FEMA on FOREX

transactions 28

9

Capital And Current Account

Convertibility 31

10 Case Study I – Ajit Kerkar

Vs Indian Hotels and Tata

36

Group

11

Case Study II – FERA

violation by ITC 42

12 Conclusion 46

13 Bibliography

INTRODUCTION

We have chosen this topic in order to understand provision laid by FERA and the difficulty or

problems faced by the individuals in abiding the provision. Problems faced by the government to

raise foreign investment in the country.

It was due to the stringent and aggressive provisions of FERA, that the need for introduction of

FEMA was felt. After liberalization when the global markets were opened for trading and investing

provision of FERA was acting like obstacles in raising foreign currency. FEMA was introduced with

the view to simplify provisions and encourage foreign investment in the country.

Introduction of FEMA had a positive impact on FOREX as well as on money supply, FDI and FII.

To study Current Account and Capital Account Convertibility.

Need to introduce FERA

a) FERA was introduced at a time when foreign exchange (Forex) reserves of the

country were low, Forex being a scarce commodity.

b) FERA therefore 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).

c) It regulated not only transactions in Forex, but also all financial transactions

with non-residents. FERA primarily prohibited all transactions, except to the

extent permitted by general or specific permission by RBI.

Objective of FERA

The main objective of the FERA 1973 was to consolidate and amend the law

regulating:

¬ Certain payments;

¬ Dealings in foreign exchange and securities;

¬ Transactions, indirectly affecting foreign exchange;

¬ Import and export of currency, for the conservation of the foreign exchange

resources of the country;

¬ Proper utilization of foreign exchange, so as to promote the economic

development of the country.

The basic purpose of FERA was:

a) To help RBI in maintaining exchange rate stability.

b) To conserve precious foreign exchange.

c) To prevent/regulate foreign business in India

Foreign Exchange Regulation Act 1973

An Act to consolidate and amend the law regulating certain payments, dealings in foreign

exchange and securities, transactions indirectly affecting foreign exchange and the import and

export of currency, for the conservation of the foreign exchange resources of the country and the

proper utilization thereof in the interests of the economic development of the country.

(1) This Act may be called the Foreign Exchange Regulation Act, 1973.

(2) It extends to the whole of India.

(3) It applies also to all citizens of India outside India and to branches and agencies outside India

of companies or bodies corporate, registered or incorporated in India.

(4) It shall come into force on such date 1* as the Central Government may, by notification in the

Official Gazette, appoint in this behalf: Provided that different dates may be appointed for

different provisions of this Act and any reference in any such provision to the commencement of

this Act shall be construed as a reference to the coming into force of that provision.

Definitions:

Person resident in India" means -

(i) a citizen of India, who has, at any time after the 25th day of March, 1947, been staying in

India but does not include a citizen of India who has gone out of, or stays outside, India, in

either case-- (a) for or on taking up employment outside India, or (b) for carrying on outside

India a business or vocation outside India, or (c) for any other purpose, in such circumstances

as would indicate his intention to stay outside India for an uncertain period;

(ii) a citizen of India, who having ceased by virtue of paragraph (a) or paragraph (b) or

paragraph (c) of sub-clause (I) to be resident in India, returns to, or stays in, India, in either

case -(a) for or on taking up employment in India, or (b) for carrying on in India a business or

vocation in India, or.(c) for any other purpose, in such circumstances as would indicate his

intention to stay in India for an uncertain period;

(iii) a person, not being a citizen of India, who has come to, or stays in, India, in either case -(a)

for or on taking up employment in India, or (b) for carrying on in India a business or vocation in

India, or (c) for staying with his or her spouse, such spouse being a person resident in India, or

(d) for any other purposes, in such circumstances as would indicate his intention to stay in India

for an uncertain period;

(iv) a citizen of India, who, not having stayed in India at any time after the 25th day of March,

1947, comes to India for any of the purposes referred to in paragraphs (a), (b) and (c) of sub-

clause (iii) or for the purpose and in the circumstances referred to in paragraph (d) of that sub-

clause or having come to India stays in India for any such purpose and in such circumstances.

Explanation - A person, who has, by reason only of paragraph (a) or paragraph (b) or

paragraph (d) of sub-clause (iii) been resident in India, shall, during any period in which he is

outside India, be deemed to be not resident in India;

(q) "person resident outside India" means a person who is not resident in India;

(r) "precious stone" includes pearl and semi-precious stone and such other stone or gem as the

Central Government may for the purposes of this Act, notify in this behalf in the Official Gazette;

(s) "prescribed" means prescribed by rules made under this Act;

(t) "Reserve Bank" means the Reserve Bank of India;.(u) "security" means shares, stocks,

bonds, debentures, debenture stock, Government securities as defined in the Public Debt Act,

1944, savings certificates to which the Government Savings Certificates Act, 1959 applies,

deposit receipts in respect of deposits of securities, and units or sub-units of unit trusts and

includes certificates of title to securities, but does not include bills of exchange or promissory

notes other than Government promissory notes.

Authorized dealers in foreign exchange

(1) The Reserve Bank may, on an application made to it in this behalf, authorise any person to

deal in foreign exchange.

(2) An authorisation under this section shall be in writing and -

(i) may authorise transactions of all descriptions in foreign currencies or may be restricted to

authorising dealings in specified foreign currencies only;

(ii) may authorise dealings in all foreign currencies or may be restricted to authorising specified

transactions only;

(iii) may be granted to be effective for a specified period, or within specified amounts;

(iv) may be granted subject to such conditions as may be specified therein.

(3) Any authorisation granted under sub-section (1) may be revoked by the Reserve Bank at any

time if the Reserve Bank is satisfied that, - (i) it is in the public interest to do so;or (ii) the

authorised dealer has not complied with the conditions subject to which the authorisation was

granted or has contravened any of the provisions of this Act or of any rule, notification, direction

or order made thereunder:

Provided that no such authorisation shall be revoked on the ground specified in clause (ii) unless

the authorised dealer has been given a reasonable opportunity for making a representation in

the matter.

(4) Any authorised dealer shall, in all his dealings in foreign exchange and in the exercise and

discharge of the powers and of the functions delegated to him under section 74, comply with

such general or special directions or instructions as the Reserve Bank may, from time to time,

think fit to give, and, except with the previous permission of the Reserve Bank, an authorised

dealer shall not engage in any transaction involving any foreign exchange which is not in

conformity with the terms of his authorisation under this section.

(5) An authorised dealer shall, before undertaking any transaction in foreign exchange on behalf

of any person, require that person to make such declarations and to give such information as will

reasonably satisfy him that the transaction will not involve, and is not designed for the purpose

of, any contravention or evasion of the provisions of this Act or of any rule, notification, direction

or order made thereunder, and where the said person refuses to comply with any such

requirement or makes only unsatisfactory compliance therewith, the authorised dealer shall

refuse to undertake the transaction and shall, if he has reason to believe that any such

contravention or evasion as aforesaid is contemplated by the person, report the matter to the

Reserve Bank.

Money-changers

(1) The Reserve Bank may, on an application made to it in this behalf, authorise any person to

deal in HYPERLINK "http://exim.indiamart.com/act-regulations/fera-1993.html" \t "_top"

foreign currency.

(2) An authorisation under this section shall be in writing and -(i) may authorise dealings in all

foreign currencies or may be restricted to authorising dealings in specified foreign currencies

only; (ii) may authorise transactions of all descriptions in foreign currencies or may be restricted

to authorizing specified transactions only; (iii) may be granted with respect to a particular place

where alone the money changer shall carry on his business; (iv) may be granted to be effective

for a specified period, or within specified amounts; (v) may be granted subject to such

conditions as may be specified therein.

(3) Any authorisation granted under sub-section (1) may be revoked by the Reserve Bank at any

time if the Reserve Bank is satisfied that -( i) it is in the public interest to do so; or (ii) the

money-changer has not complied with the conditions subject to which the authorisation was

granted or has contravened any of the provisions of this Act or of any rule, notification, direction

or order made there under:

Provided that no such authorisation shall be revoked on the ground specified in clause (ii) unless

the money-changer has been given a reasonable opportunity for making a representation in the

matter.

(4) The provisions of sub-sections (4) and (5) of section 6 shall, in so far as they are applicable,

apply in relation to a money-changer as they apply in relation to an authorised dealer.

Explanation - In this section, "foreign currency" means foreign currency in the form of notes,

coins or traveller's cheques and "dealing" means purchasing foreign currency in the form of

notes, coins or traveller's cheques or selling foreign currency in the form of notes or coins.

Restrictions on dealing in foreign exchange

(1) Except with the previous general or special permission of the Reserve Bank, no person other

than an authorised dealer shall in India, and no person resident in India other than an

authorised dealer shall outside India, purchase or otherwise acquire or borrow from, or sell, or

otherwise transfer or lend to or exchange with, any person not being an authorised dealer, any

foreign exchange:

Provided that nothing in this sub-section shall apply to any purchase or sale of foreign currency

effected in India between any person and a money-changer.

Explanation - For the purposes of this sub-section, a person, who deposits foreign exchange

with another persons or opens an account in foreign exchange with another person, shall be

deemed to lend foreign exchange to such other person.

(2) Except with the previous general or special permission of the Reserve Bank, no person,

whether an authorised dealer or a money-changer or otherwise, shall enter into any transaction

which provides for the conversion of Indian currency into foreign currency or foreign currency

into Indian currency at rates of exchange other than the rates for the time being authorised by

the Reserve Bank.

(3) Where any foreign exchange is acquired by any person, other than an authorised dealer or a

money-changer, for any particular purpose, or where any person has been permitted

conditionally to aquire foreign exchange, the said person shall not use the foreign exchange so

acquired otherwise than for that purpose or, as the case may be, fail to comply with any

condition to which the permission granted to him is subject, and where any foreign exchange so

acquired cannot be so used or the conditions cannot be complied with, the said person shall,

within a period of thirty days from the date on which he comes to know that such foreign

exchange cannot be so used or the conditions cannot be complied with, sell the foreign exchange

to an authorised dealer or to a money-changer.

(4) For the avoidance of doubt, it is hereby declared that where a person acquires foreign

exchange for sending or bringing into India any goods but sends or brings no such goods or does

not send or bring goods of a value representing the foreign exchange acquired, within a

reasonable time or sends or brings any goods of a kind, quality or quantity different from that

specified by him at the time of acquisition of the foreign exchange, such person shall, unless the

contrary is proved, be presumed not to have been able to use the foreign exchange for the

purpose for which he acquired it or, as the case may be, to have used the foreign exchange so

acquired otherwise than for the purposes for which it was acquired.

(5) Nothing in this section shall be deemed to prevent a person from buying from any post

office, in accordance with any law or rules made thereunder for the time being in force, any

foreign exchange in the form of postal orders or money orders.

Contraventions and Penalties under FERA

One of the main reasons to fear FERA was, the unbridled power the enforcement

authorities had, to arrest any person almost at their whim and fancy. Under Sec.

35 of FERA, any officer authorized by the Central government can arrest any

person on mere suspicion of his having committed an offence under the Act. This

is one of the most obnoxious and most misused provisions of FERA.

Any offence under FERA, was a criminal offence, punishable with imprisonment as

per code of criminal procedure, 1973

The monetary penalty payable under FERA, was nearly the five times the amount

involved.

Need to introduce FEMA

For the past over one year, one has been reading and hearing a lot about the new Foreign

Exchange Management Act (FEMA), which was to replace the Foreign Exchange Regulation Act,

1973 (FERA). FEMA was ultimately passed by Parliament in 1999, but was to take force from the

date of notification. Ultimately now, it has been notified that FEMA has come into force from 1st

June 2000.

Why was it necessary to replace FERA by FEMA?

How different is FEMA from FERA? Is it merely change of one word, from "Regulation" to

"Management"?

How does the change from FERA to FEMA affect common citizens such as you, who are Indian

residents not engaged in imports or exports?

To understand the difference, one needs to understand the underlying principles of FERA. FERA

was introduced at a time when foreign exchange (forex) reserves of the country were low, forex

being a scarce commodity. FERA therefore 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) expeditiously. It regulated not

only transactions in forex, but also all financial transactions with non-residents. FERA primarily

prohibited all transactions, except to the extent permitted by general or specific permission by

RBI.

Violation of FERA was a criminal offence. One has heard so many stories of people being

imprisoned for trivial offences. The case of the eminent industrialist, S.L.Kirloskar, being

proceeded against under FERA for having the princely amount of $82 (or was it $86?) in his

possession is well known. If you had ever visited a relative abroad, or had non-resident relatives

visiting you, the chances are high that you had also violated FERA. In such cases, it is highly likely

that your relatives may have given you or your visiting family members some small gift in forex,

which you spent on buying some small article which you wanted to bring back. Or you may have

spent some money on hospitality towards your non-resident relatives visiting you. Strictly,

speaking, till the 1990's, these were FERA violations. Thank your lucky stars that you were not

considered prominent enough for being punished under FERA. FERA had become more of a tool in

the hands of politicians for punishing people who refused to toe their line.

Fortunately, with the winds of liberalization blowing in the early 1990's, the Government relaxed

many of the rigors of FERA by issuing notifications. Forex reserves swelled, the rupee was made

convertible on current account. In this liberal atmosphere, the government realized that

possession of forex could no longer be regarded as a crime, but was an economic offence, for

which the more appropriate punishment was a penaly. Thus, the need of FEMA was felt. The

primary difference between FERA and FEMA therefore lies in the fact that offences under FEMA are

not regarded as criminal offences and only invite penalties, not prosecution and imprisonment.

FEMA now codifies in the legislation and rules itself various transactions, which had been

permitted by notification under FERA. Under FEMA, all current account transactions in forex (such

as expenses, which are not for capital purposes) are permitted, except to the extent that the

Central Government notifies. However, so far as capital account transactions are concerned, all

capital account transactions in forex are prohibited, except to the extent as may be notified by

RBI.

Does this mean that you can spend unlimited forex on whatever you want, so long as it is not a

capital expense, such as investment? Certain prohibitions are laid down in the Foreign Exchange

Management (Current Account Transactions) Rules, 2000. You cannot remit money for purchase

of lottery tickets, for subscription to banned/prescribed magazines, to football pools, sweepstakes,

for payment for telephone callback services, etc. Under the rules, certain remittances can be

made only with prior approval of RBI. Many of these require permission only if the spending

exceeds a particular limit. In effect, this means that you can spend amounts less than that

without any approval being required.

Some of these remittances, not requiring approval, are:

1. Up to US $ 5,000 in every calendar year for foreign travel (increased from the limit of US $

3,000 under FERA).

2. Up to US $ 25,000 per trip for a business trip or for attending a conference abroad, irrespective

of the length of the trip (under FERA, you had limits per day plus an entertainment allowance).

3. For gifts up to US $ 5,000 per beneficiary per annum (under FERA, the limit was US $ 1,000

and restricted only to defined relatives).

4. For donations up to US $ 5,000 per beneficiary.

5. For maintenance of close relatives abroad up to US $ 5,000 per recipient.

6. For foreign studies up to US $ 30,000, or the estimate from the foreign institution, whichever is

higher.

7. For meeting expenses for medical treatment abroad, up to the estimate from doctor in India or

hospital or doctor abroad.

There do not seem to be any restrictions on payments to be made in forex for various sundry

expenses, such as purchase of books or software for your own use, for which there were certain

limits under FERA.

If you have received forex as a gift abroad or earned it from a non-resident or on a visit abroad or

acquired it for spending a foreign trip, you can now retain up to US $ 2,000 in forex even after

your return to India, besides any amount of coins that you may choose to keep.

Of course, since capital account transactions are still prohibited (except to the extent permitted),

you still cannot invest your funds in overseas investments (unless you are an employee of a

foreign company or its subsidiary and have been offered stock options in the foreign company).

Hopefully, judging by the past trends relating to liberalisation of forex regulations and the

intention behind FEMA, that day will not be too far off! BSE and NSE would then need to be watch

out - NASDAQ may soon replace them as the Indian investor's favorite exchange.

Foreign Exchange Management Act

Foreign Exchange Management Act or in short (FEMA) is an act that provides guidelines for the

free flow of foreign exchange in India. It has brought a new management regime of foreign

exchange consistent with the emerging frame work of the World Trade Organisation (WTO).

Foreign Exchange Management Act was earlier known as FERA (Foreign Exchange Regulation Act),

which has been found to be unsuccessful with the proliberalisation policies of the Government of

India.

FEMA is applicable in all over India and even branches, offices and agencies located outside India,

if it belongs to a person who is a resident of India.

Some Highlights of FEMA

It prohibits foreign exchange dealing undertaken other than an authorised person;

It also makes it clear that if any person residing in India, received any Forex payment (without

there being a corresponding inward remittance from abroad) the concerned person shall be

deemed to have received they payment from a un-authorized person.

There are 7 types of current account transactions, which are totally prohibited, and therefore no

transaction can be undertaken relating to them. These include transaction relating to lotteries,

football pools, banned magazines and a few others.

FEMA and the related rules give full freedom to Resident of India (ROI) to hold or own or transfer

any foreign security or immovable property situated outside India.

Similar freedom is also given to a resident who inherits such security or immovable property from

an ROI.

An ROI is permitted to hold shares, securities and properties acquired by him while he was a

Resident or inherited such properties from a Resident.

The exchange drawn can also be used for purpose other than for which it is drawn provided drawl

of exchange is otherwise permitted for such purpose.

Certain prescribed limits have been substantially enhanced. For instance, residence now going

abroad for business purpose or for participating in conferences seminars will not need the RBI's

permission to avail foreign exchange up to US$. 25,000 per trip irrespective of the period of stay,

basic travel quota has been increased from the existing US$ 3,000 to US$ 5,000 per calendar

year.

Recent Amendment to FEMA:

Opening of Foreign Currency Accounts Outside India

Earlier, Indian Companies which needed to open foreign currency accounts outside India needed

to take the approval of the RBI. This was a cumbersome and time consuming process.

This has now been liberalized by the Foreign Exchange Management (Foreign Currency Accounts

by a Person Resident in India) (Second Amendment) Regulations, 2001issued by the RBI on

December 5th 2001.

Under these regulations, an Indian Entity can now open a Bank Account outside India without any

prior approval from the RBI / Authorize Dealer, subject to the following limits on remittances :

Source of Remittance

Amount which can be remitted for initial expenses

Amount which can be remitted for recurring expenses

A 100% EOU or a unit in EPZ or in a Hardware Technology Park or in a Software Technology Park, within two years of establishment of the Unit

From out of its Current A/c or out of its EEFC(exchange earner foreign currency account) A/c

No Limit No Limit

Other Companies From out of its Current A/c

2 per cent of the average annual sales/income or turnover during last two accounting years of the Indian Entity.

1 per cent of the average annual sales/income or turnover during last two accounting years of the Indian Entity.

From out of its EEFC A/c

No Limit No Limit

Two way Fungiabiltiy for ADR / GDRs

Two Way fungibility of ADR / GDR issued by Indian Companies was permitted by the Government

of India & the RBI. The RBI has now, vide APDIR Circular No: 21 dated February 13th 2002,

issued operative guidelines for the 2 way fungibility of ADR / GDR.

Earlier, once a company issues ADR / GDR, and if the holder wanted to obtain the underlying

equity shares of the Indian Company, then, such ADR / GDR would be converted into shares of

the Indian Company. Once such conversion has taken place, it was not possible to reconvert the

equity shares into ADR / GDR.

The present rules of the RBI make such reconversion possible, to the extent of ADR / GDR which

have been converted into equity shares and sold in the local market. This would take place in the

following manner:

Stock Brokers in India have been authorized to purchase shares of Indian Companies for

reconversion.

The Domestic Custodian would coordinate with the Overseas Depository and the Indian Company

to verify the quantum of reconversion which is possible and also to ensure that the sectoral cap is

not breached.

The Domestic Custodian would then inform the Overseas Depository to issue ADR / GDR to the

overseas Investor.

Investment outside India by Indian Companies:

Pursuant to the Union Budget, outbound investment by Indian Companies has been further

liberalized. The highlights of these changes are:

Indian Companies are now permitted to invest up to 100 Million US Dollars per financial year

under the automatic route, provided the other conditions as specified in FEMA Notification No:

19/2000 dated 3rd May 2000 are complied with. Earlier the limit for investment under the

Automatic Route was 50 Million US Dollars per financial year.

Companies which do not have access to foreign exchange for overseas investments are permitted

to purchase foreign exchange from the Authorized Dealers up to 50% of their net worth. Earlier,

the limit was 25% of their net worth.

Issue of Foreign Currency Convertible Bonds by Indian Companies.

Earlier, Indian Companies required approval of the Government of India before issue of Foreign

Currency Convertible Bonds (FCCBs). The RBI has vide FEMA Notification No: 55 dated March

7th2002, liberalized these rules. Accordingly:

Indian Companies seeking to raise FCCBs are permitted to raise them under the Automatic Route

up to US 50 Million Dollars per financial year without any approval.

The FCCBs raised shall be subject to the sectoral limits prescribed by the Government of India.

Maturity period for the FCCBs shall be at least 5 years and the "all in cost" at least 100 basis

points less than that prescribed for External Commercial Borrowings

Recent Proposals:

Govt to allow foreign MNCs to impose annual service fee-27 Jan 2009 ET:The government is

considering a proposal to allow foreign multinationals to impose an 'annual service fee' on their

Indian subsidiary for providing management services. The foreign direct HYPERLINK

"http://economictimes.indiatimes.com/News/Economy/Policy/Govt-to-allow-foreign-MNCs-to-

impose-annual-service-fee/articleshow/4038514.cms" investment (FDI) policy, while allowing

payment of royalty, license fee and technical know how-how fee, does not provide for payment of

annual service fee by Indian subsidiaries.

Fema to apply to reverse overseas M&As, says RBI –The RBI has said Indian companies merging

with overseas firms will continue to be treated as entities resident in the country under the

FEMA.There is no provision for such a merger under the current Companies Act. But a Bill to

amend the Act tabled in the Budget session of Parliament proposes to allow Indian companies to

merge with overseas companies, under section 205, a move that could introduce greater flexibility

in cross-border merger and acquisitions (M&As). The central bank has also clarified that payment

by the foreign company to shareholders of listed Indian companies being merged can be made in

the form of cash, shares or Indian Depository Receipts (IDRs) issued by the overseas companies.

In this case, RBI has clarified that Fema will have to amended suitably. Besides, IDRs in their

existing form do not have voting rights and the law has to be changed to incorporate this change.

This will be important if the merger involves allotting voting rights to Indian shareholders or some

sort of management control.

New provisions for a "Status Holder"

The Export Import Policy issued by the Government of India, has created a new class of Exporters

termed as "Status Holder". A "Status Holder" has been granted the following concessions under

the FEMA Regulations:

A Status Holder is entitled to credit 100% of his foreign exchange earnings into the EEFC A/c.

Earlier, this facility was available only to units in the Special Economic Zones and other companies

which had obtained specific RBI approval for doing so.

In case of exports made by a Status Holder, a time limit of 12 months has been granted to realize

the export proceeds, as against 6 months in the case of other exporters. The time limit of 12

months was earlier available only in case of exports made by units in the Special Economic Zones.

Contraventions and Penalties

If any person contravenes any provision of this Act, or contravenes any rule, regulation,

notification, direction or order issued in exercise of the powers under this Act, or contravenes any

condition subject to which an authorization is issued by the Reserve Bank, he shall, upon

adjudication, be liable to a penalty up to thrice the sum involved in such contravention where such

amount is quantifiable, or up to two lakh rupees where the amount is not quantifiable, and where

such contravention is a continuing one, further penalty which may extend to five thousand rupees

for every day after the first day during which the contravention continues.

Any Adjudicating Authority adjudging any contravention may, if he thinks fit in addition to any

penalty which he may impose for such contravention direct that any currency, security or any

other money or property in respect of which the contravention has taken place shall be

confiscated to the Central Government and further direct that the foreign exchange holdings, if

any, of the persons committing the contraventions or any part thereof, shall be brought back into

India or shall be retained outside India in accordance with the directions made in this behalf.

"Property" in respect of which contravention has taken place, shall include deposits in a bank,

where the said property is converted into such deposits, HYPERLINK

"http://en.wikipedia.org/w/index.php?title=Indian_currency&action=edit&redlink=1" \o "Indian

currency (page does not exist)" Indian currency, where the said property is converted into that

currency; and any other property which has resulted out of the conversion of that property.

If any person fails to make full payment of the penalty imposed on him within a period of ninety

days from the date on which the notice for payment of such penalty is served on him, he shall be

liable to civil imprisonment

FERA VS FEMA

Sr. No DIFFERENCES FERA FEMA

1

PROVISIONS FERA consisted of 81

sections, and was

more complex

FEMA is much

simple, and consist

of only 49 sections.

2

FEATURES Presumption of

negative intention

(Mens Rea ) and

joining hands in

offence (abatement)

existed in FEMA

These presumptions

of Mens Rea and

abatement have

been excluded in

FEMA

3

NEW TERMS IN FEMATerms like Capital

Account Transaction,

current Account

Transaction, person,

service etc. were not

defined in FERA.

Terms like Capital

Account Transaction,

current account

Transaction person,

service etc., have

been defined in detail

in FEMA

4

DEFINITION OF

AUTHORISED

PERSON

Definition of

"Authorised Person"

in FERA was a

narrow one ( 2(b)

The definition of

Authorised person

has been widened to

include banks,

money changes, off

shore banking Units

etc. (2 ( c )

5 MEANING OF

"RESIDENT" AS

COMPARED WITH

There was a big

difference in the

definition of

The provision of

FEMA, are in

consistent with

INCOME TAX ACT. "Resident", under

FERA, and Income

Tax Act

income Tax Act, in

respect to the

definition of term "

Resident". Now the

criteria of "In India

for 182 days" to

make a person

resident has been

brought under FEMA.

Therefore a person

who qualifies to be a

non-resident under

the income Tax Act,

1961 will also be

considered a non-

resident for the

purposes of

application of FEMA,

but a person who is

considered to be

non-resident under

FEMA may not

necessarily be a non-

resident under the

Income Tax Act, for

instance a business

man going abroad

and staying therefor

a period of 182 days

or more in a financial

year will become a

non-resident under

FEMA.

6

PUNISHMENT Any offence under

FERA, 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.

7

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.

8 APPEAL An appeal against

the order of

"Adjudicating office",

before " Foreign

Exchange Regulation

Appellate Board went

before High Court

The appellate

authority under

FEMA is the special

Director

( Appeals)Appeal

against the order of

Adjudicating

Authorities and

special Director

(appeals) lies before

"Appellate Tribunal

for Foreign

Exchange."An appeal

from an order of

Appellate Tribunal

would lie to the High

Court. (sec

17,18,35)

9

RIGHT OF

ASSISTANCE

DURING LEGAL

PROCEEDINGS.

FERA did not contain

any express

provision on the

right of on impleaded

person to take legal

assistance

FEMA expressly

recognises the right

of appellant to take

assistance of legal

practitioner or

chartered accountant

(32)

10

POWER OF SEARCH

AND SEIZE

FERA conferred wide

powers on a police

officer not below the

rank of a Deputy

Superintendent of

Police to make a

search

The scope and power

of search and seizure

has been curtailed to

a great extent

Position under FERA :

• No person resident outside India could own immovable property in India, without the approval

of the Reserve Bank of India (RBI)

• Certain relaxations permitted by issue of circulars and notifications by RBI for NRIs owning

residential houses for their personal use, property inherited etc.

• First set of liberalization measures introduced to permit NRIs and Overseas Corporate Bodies

(OCBs) to invest in real estate development projects, subject to certain conditions [Under FEMA

OCB de-recognized as a category after September 2003]

• Repatriation of original investment by NRIs/ OCB permitted by RBI only after lock in period of 3

years from date of issue

• OCBs permitted to repatriate net profits (upto 16%) arising from sale of such investment after

the lock-in period of 3 years

Dividend/ interest on equity shares/ debentures allowed to be remitted subject to necessary

approvals without any lock –in period.

• No other person resident outside India was eligible to invest in real estate development projects.

• Real estate development activity was limited to the following six activities:

– Development of serviced plots and construction of built up residential premises

– Construction of residential and commercial premises including business centers and offices.

– Development of townships – City and regional level urban infrastructure facilities, including

roads and bridges.

– Manufacture of building materials

– Financing of housing development

Position under FEMA:

• Capital Account Transactions governed by Section 6 of FEMA

• Capital Account transactions defined in Section 2 (e) of FEMA

• RBI empowered to frame regulations and make rules etc. in consultation with the Central

Government.

• Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000

(Capital Account Regulations)

• Schedule II of Capital Account Regulations specifies classes of permissible capital account

transactions for non-residents.

• Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside

India) Regulations, 2000 prescribe conditions for investments by persons residents outside India

(TIS Regulations).

SIMILARITIES

The similarities between FERA and FEMA are as follows:

• The Reserve Bank of India and central government would continue to be the regulatory bodies.

• The Directorate of Enforcement continues to be the agency for enforcement of the provisions of

the law such as conducting search and seizure.

Pre-shipment credit

Pre-shipment credit is also know as Export Packing Credit which is availed by an expoter from his

bank for the purpose of procurement of RM, processing of RM for converting into finished goods

and for other incidental expenses such as payment of wages, packing expenses, freight,

insurance, etc. In India packing credit is given at concessive rate as a part of export promotion.

The adjustment of Paacking credit is done out of the proceeds of export bills submitted by the

exporter to his Bank. PC in Foriegn Currency is also permitted.

The main objectives behind preshipment finance or pre export finance is to enable exporter to:

Procure raw materials.

Carry out manufacturing process.

Provide a secure warehouse for goods and raw materials.

Process and pack the goods.

Ship the goods to the buyers.

Meet other financial cost of the business.

Types of Pre Shipment Finance

Packing Credit

Advance against Cheques/Draft etc. representing Advance Payments.

Post - Shipment Credit:

Post-shipment Credit is granted to exporter by the bank after the shipment is made by him and

against presentation of export documents under confirmed contract or letter of credit. This credit

is also granted at concessive rate of interest and gets adjusted from the remittance of proceeds of

export documents received from overseas. Post - shipment credit in FC is also permitted.

Both Pre-shipment & Post-shipment credit are considered as preferred sector advances and all

AD's are advised to grant at least 12% of their net advances in the form of export credit.

Basic Features

The features of post shipment finance are:

Purpose of Finance:

Post shipment finance is meant to finance export sales receivable after the date of

shipment of goods to the date of realization of exports proceeds. In cases of deemed

exports, it is extended to finance receivable against supplies made to designated agencies.

Basis of Finance:

Postshipment finances is provided against evidence of shipment of goods or supplies made

to the importer or seller or any other designated agency.

Types of Finance

Post shipment finance can be secured or unsecured. Since the finance is extended against

evidence of export shipment and bank obtains the documents of title of goods, the finance

is normally self liquidating. In that case it involves advance against undrawn balance, and

is usually unsecured in nature.

Further, the finance is mostly a funded advance. In few cases, such as financing of project

exports, the issue of guarantee (retention money guarantees) is involved and the financing

is not funded in nature.

Quantum of Finance:

As a quantum of finance, post shipment finance can be extended up to 100% of the invoice

value of goods. In special cases, where the domestic value of the goods increases the

value of the exporter order, finance for a price difference can also be extended and the

price difference is covered by the government. This type of finance is not extended in case

of preshipment stage.

Banks can also finance undrawn balance. In such cases banks are free to stipulate margin

requirements as per their usual lending norm.

Period of Finance:

Post shipment finance can be off short terms or long term, depending on the payment

terms offered by the exporter to the overseas importer. In case of cash exports, the

maximum period allowed for realization of exports proceeds is six months from the date of

shipment. Concessive rate of interest is available for a highest period of 180 days, opening

from the date of surrender of documents. Usually, the documents need to be submitted

within 21days from the date of shipment.

Types of Post Shipment Finance

The post shipment finance can be classified as :

Export Bills purchased/discounted.

Export Bills negotiated

Advance against export bills sent on collection basis.

Advance against export on consignment basis

Advance against undrawn balance on exports

Advance against claims of Duty Drawback.

IMPACT ON FOREX TRANSACTIONS

Primary Purpose:

– Conserve foreign exchange

– Protect Indian industry and economy

• Relaxations:

– Fully convertible on current account

– Capital convertibility norms liberalized

• Way Forward:

– Complete deregulation

– Full capital account convertibility

– Removal of sectorial caps

The foreign exchange market in India is regulated by the RBI through the Exchange Control

Department. The Forex market in India consists of buyers, sellers, market intermediaries & the

monetary authority of India. Mumbai [the commercial capital of India] is the main center for

foreign exchange transactions in India. There are many other centers for foreign exchange

transactions in the country such as Chennai, Bangalore, Kolkata, New Delhi, Pondicherry and

Cochin.

FOREX concept

The flow of funds across the national boundaries happens because of the trade and personal

remittances. Inward remittances are on account of exports and remittances from Indians working

abroad. These remittances result in flow of foreign currency into the country. The foreign funds

accumulate with the Indian banks that pay out equivalent Indian rupees to the beneficiaries of the

remittances in India.

Indian banks accumulate the foreign currency funds in current accounts maintained with banks at

foreign centers such as London and New York. Thus, foreign inward remittances result in increase

in money in circulation. On the other hand, foreign outward remittances lead to contraction of

money in circulation and outflow of foreign currency from the stock with Indian banks.

Banks having surplus foreign currency funds sells the funds to other Indian banks in exchange of

Indian Rupees. If all banks have surplus foreign currency funds they sell these to the RBI.

Balances in the foreign currency accounts of RBI become the foreign exchange reserve of the

country.

Impact of FEMA on FOREX

Until 1992 all foreign investments in India and the repatriation of foreign capital

required previous approval of the government. The foreign-Exchange regulation

Act rarely allowed foreign majority holdings for foreign exchange in India.

However, a new foreign investment policy announced in July 1991, declared

automatic approval for foreign exchange in India for thirty-four industries. These

industries were designated with high priority, up to an equivalent limit of 51%.

The foreign exchange market in India is regulated by the Reserve Bank of India

through the Exchange Control Department.

Initially the government required that a company’s routine approval must rely on

identical exports and dividend repatriation, but in May 1992 this requirement of

foreign exchange in India was lifted, with an exception to low-priority sectors. In

1994 foreign and non resident Indian investors were permitted to repatriate not

only their profits but also their capital for foreign exchange in India. Indian

exporters are enjoying the freedom to use their export earnings as they find it

suitable. however, transfer of capital abroad by Indian nationals is only allowed in

particular circumstances, such as emigration. Foreign exchange in India is

automatically made accessible for imports for which import licences are widely

used.

Indian authorities are able to manage the exchange rate easily, only because

foreign exchange transactions in India are so securey controlled. From 1975 to

1992 the rupee was coupled to a trade-weighted basket of currencies. In

February 1992, the Indian government started to make the rupee convertible,

and in March 1993 a single floating exchange rate in the market of foreign

exchange in India was implemented. In July 1995, Rs 31.81 was worth US$1, as

compared to Rs 7.86 in 1980, Rs 12.37 in 1985 and Rs 17.50 in 1990.

Since the onset of liberalization, foreign exchange markets in India have

witnessed explosive growth in trading capacity. The importance of the exchange

rate of foreign exchange in India for the Indian economy has also been far

greater than ever before. While the Indian government has clearly adopted a

flexible exchange rate regime, in practice the rupee is one of most resourceful

tracker of the US dollar.

The foreign exchange market in India is growing very rapidly, since the annual

turnover of the market is more than $400 billion.

Impact on money supply

In context of the Indian financial system, the relevant factor is that the increase in foreign

currency reserves as a result of the larger foreign inward remittances, lead to increase in money

supply; finding its way into the money market and capital market through the banking system.

Banks create credit and any inflow into the banking system gets multiplied by a factor. This factor

depends on the reserves maintained by banks. If banks maintain n average reserve of 25%, any

inflow into the banking system will increase money supply four times.

Similarly, any contraction of funds available with the banks will result in a four-fold reduction in

money supply. Increase and decrease in the foreign exchange reserves of the country impact the

financial system through increase or decrease in money supply.

Foreign Direct Investment [FDI] & Foreign Institutional Investors [FII]

Another aspect of Foreign Exchange market is that apart from flows resulting from personal and

trade remittances, banks and corporate borrow funds from abroad and foreign entities invest in

Indian business entities, such as Foreign Direct Investment [FDI], foreign funds and Foreign

Institutional Investors [FII] that invest in the Indian capital markets. These flows are large in

magnitude and have a great impact on capital market and the exchange rate.

However, there is also the danger that if FIIs pull out, the stock markets could crash which in turn

can adversely impact the economy. This danger is not only on account of the impact of share

prices but also because of the impact on exchange rate, which can adversely affect foreign trade

and consequently the price level in the country.

Capital Account Convertibility

The FEMA divides transactions according to their nature - that is, as current account and capital

account. The regulation of foreign exchange too varies according to the nature of transaction.

Sale or withdrawals of foreign exchange on current account transactions are made free under

Section 5 of the FEMA. This freedom is subject to the power of the Centre to prescribe, in public

interest, reasonable restriction on current account transactions in consultation with the RBI, the

regulator.

In terms of Section 6, the RBI, in consultation with the Centre, specifies the permissible capital

account transactions. Thus, there is no free capital convertibility, rightly so, and the extent is

prescribed by the regulator.

The liberal provision on current account transactions is in line with the Article IX status of India in

the IMF that demands full current account convertibility. The present forex reserves of about $34

billions are sufficient to remove all restrictions on current account transactions and facilitate trade

and payments.

Even under the FERA regime, current account transactions were progressively liberalized since

August 1994, through various notifications: including payment in foreign exchange towards

dividends, investment income, commission, compensation for engagement of foreign technician,

technology payments, and consultation charges and so on.

In effect, liberal treatment of current account transactions, available through various notifications

or circulars under the FERA, is made statutory in FEMA. Does this mean that the notifications or

circulars are no longer relevant? That the RBI has little to do in the `management' regime?

Inevitably, one can expect a spate of notifications under FEMA too and the regulator will face new

types of challenges in the changed scenario. The statutory expression `current' and `capital'

account transactions may open up a controversy requiring the regulator's intervention and

clarification.

Simply put, a capital account transaction is defined to mean a transaction that alters the asset or

liabilities located outside India of a resident or those of an NRI in India. In addition, Section 6(3)

brings under the definition, specific types of capital transactions.

A current account transaction is defined to mean one other than a capital transaction. Here, too,

certain obvious current accounts dealings, such as payments due in connection with foreign trade,

interest, foreign travel, and so on, are roped into the definition and have the potential to cause

misunderstandings.

For instance, if a current account payment is not paid (but is `payable'), and a provision made in

the books of the Indian firm, it becomes a liability. Once a liability, it amounts to a capital account

transaction as per the statutory definition. This is because the term capital account transaction

does not restrict itself to `long-term' assets and liabilities, but includes short-term liabilities and

assets as well.

Thus, a current account transaction for accounting purposes could become a capital transaction

legally. Those in dire need of making a payment may have to justify them under the `other

current business' set out under the definition of a current account transaction. There is greater

incentive for ingenuity in interpretation, as any contravention of the FEMA is only treated as civil

wrong.

Likewise, if a capital account transaction is split into several seemingly current account dealings, it

may escape the legislator. This apart, when public interest so demands, the regulator may bring

in a restriction even on current account dealings. All these would necessitate

descriptions/clarifications through a series of notifications or circulars by the regulator. The fact

that there cannot be any precise definition of what is current or capital transactions contributed to

the bulk of litigation under the income-tax laws.

Simply because a transaction involves a `lump-sum', it cannot be said that it is a `capital' one. If

the character of the transaction itself is current account, will the regulator allow the transaction

freely, regardless of any ceilings? The regulator ca nnot afford to give a free hand to the whims of

foreign exchange users; especially as most of the forex reserves is `hot money'.

To do so, in substance, would mean restoring the `regulation' part of the Act. The legislator is

probably aware of this, as evident from the critical and the operative part of FEMA - Chapter II

that deals with the `Regulation and management of foreign exchange'.

The provisions relating to the realization of export (a current account transaction covered under

Section 18 in FERA) is substantially contained under Section 7 of FEMA. The new law includes

export of services too. Unlike other current account transactions, exports are expressly regulated,

as the full value of export proceeds should be quickly realized in foreign exchange in the larger

interest of the forex reservoir. According to the estimate three years before, about $11.6 billions

of forex resources were lost through over-invoicing imports and under-invoicing exports.

(In effect, the only significant change lies in drastically reducing the penal consequences under

FEMA.) In all other aspects, the old law of regulation is substantially retained though, of course, in

a different form. The elimination of threat of penal provisions may prompt forex users to take

advantage of the inherently `subjective' provisions in the operative part of the Act. In this sense,

the change is a challenge to the regulator. To counter this, the regulator is bound to accelerate

the spate of circulars and clarifications. This way, the foreign exchange market continues to have

more of regulation than management.

Following are the pre-requisites for Capital Account Convertibility in India:

The Tarapore Committee appointed by the Reserve Bank of India (RBI) was meant for

recommending methods of converting the Indian Rupee completely. The report submitted by this

Committee in the year 1997 proposed a three-year time period (1999-2000) for total conversion

of Rupee. However, according to the Committee, this was possible only when the following few

conditions are satisfied:

• The average rate of inflation should vary between 3% to 5% during the debt-servicing time

• Decreasing the gross fiscal deficit to the GDP ratio by 3.5% in 1999-2000

Evolution of CAC in India economic and financial scenarios:

In 1994 August, the Indian economy adopted the present form of Current Account Convertibility,

compelled by the International Monetary Fund (IMF) Article No. VII, the article of agreement. The

primary objective behind the adoption of CAC in India was to make the movement of capital and

the capital market independent and open. This would exert less pressure on the Indian financial

market. The proposal for the introduction of CAC was present in the recommendations suggested

by the Tarapore Committee appointed by the Reserve Bank of India.

Reasons for the introduction of CAC in India:

The logic for the introduction of complete capital account convertibility in India, according to the

recommendations of the Tarapore Committee, is to ensure total financial mobility in the country.

It also helps in the efficient appropriation or distribution of international capital in India. Such

allocation of foreign funds in the country helps in equalizing the capital return rates not only

across different borders, but also escalates the production levels. Moreover, it brings about a fair

allocation of the income level in India as well.

The forecasts made by the Tarapore Committee regarding Indian CAC are as follows:

• A prescribed average inflation rate of 3% to 5% will exist for a three-year time period,

from1997-98 and 1999-2000.

• The non-performing assets will experience a decline to 12%, 9% and 5% by the years 1997-98,

1998-99 and 1999-2000 respectively, with respect to the total or aggregate advances.

• By the years 1997-98, there will be a complete deregulation of the structure of interest rate.

• The gross fiscal deficit will fall from 4.5% in 1997-98 to 4.0% in 1998-99 and further to 3.5 %

in 1999-2000, with respect to the GDP.

Benefits and drawbacks of CAC:

To sum up, CAC is concerned about the ownership changes in domestic or foreign financial assets

and liabilities. It also represents the formation and liquidation of financial claims on or by the

remaining world. It enables relaxation of the Capital Account, which is under tremendous pressure

from the commercial sectors of India. Along with the financial capitalists, the reputed commercial

firms in India jointly derive and enjoy the benefits of the CAC policy, which speculate the stock

markets through investments. In fact, the CAC policy in India is pursued primarily to gain the

speculator's and the punter's confidences in the stock markets. However, CAC does not serve the

purposes of the real sectors of Indian economy, like eradication of poverty, escalation of the

employment rates and other inequalities.

In spite of CAC being present in Indian economy, there will be a co-existence of financial crises.

Despite several benefits, CAC has proved to be insufficient in solving the Indian financial crises,

the complete solution of which lies in having a regulated inflow of capital into the economy.

Case Study I

MR. Ajit Kerkar VS Indian Hotels and Tata Group

I was begging for two years for money from various people."

-Ajit Kerkar, former CMD, Indian Hotels.

"Indian Hotels had done very well under Kerkar, but the focus had been on expansion. As a result,

the company had become country's largest hotel chain. But only five properties contributed nearly

80% of the revenue, while the rest was a drain on the company."

Ratan Tata, Chairman, Indian Hotels and Tata Group.

"There are no investigations into the acquisition of Cox and Kings. The so-called investigation at

best could be a routine inquiry by the investigating agency in response to a mischievous

complaint by a former employee of Taj who was dismissed from the services of the company."

Ajit Kerkar's comment on the investigation by the Economic Intelligence Bureau.

Introduction

On September 2, 1997, in the board meeting of Indian Hotels Co. Ltd. (IHCL), Ratan Tata took

over as the chairman of IHCL, after the former chairman and managing director, Ajit Baburao

Kerkar (Kerkar), was made to resign. R.K. Krishna Kumar (Kumar), managing director of Tata

Tea, was appointed the new Managing Director and S. Ramakrishnan of Tata Industries was made

the Deputy Managing Director.

Kerkar was asked to leave after two allegations of FERA violations surfaced: the non-repatriation

of dollar deposits by two foreign airlines, which had offices on the Taj premises in Mumbai; and

issue of Global Depositary Receipts (GDR) by IHCL's subsidiary, Oriental Hotels, amounting to

about US$30 million.

The Tatas leveled serious charges of misdemeanor and irregularity against Kerkar, who had by

then become a legend in the hotel industry for turning a single loss making property (the Taj

Mahal Hotel in Mumbai) into a reputed international chain.

Commenting on Kerkar's exit, a leading national daily wrote, "Building an international hotel chain

during the most draconian days of the Foreign Exchange Regulation Act (FERA) obviously could

not have happened without plenty of tightrope walking and some maneuvering on either side of

the law."

The exit of Kerkar put an end to the era of 'entrepreneur-manager' style of management

encouraged by JRD Tata. It was replaced with Ratan Tata's style, which was more oriented

towards maximizing shareholder's value through group vision, better disclosure practices,

transparency in corporate conduct and proper succession planning.

The Rise of Kerkar

Kerkar joined IHCL in January 1962 as assistant catering manager. He began his career with J.

Lyon & Company in London where he qualified in hoteliering. Climbing the ladder quickly, Kerkar

became the general manager of the badly managed and poorly run Taj Mahal Hotel, Mumbai, in

1968.

In 1970, he became its managing director. Kerkar was one of the 'super managers' appointed by

JRD Tata, who were given full freedom to run the different wings of the family empire in their

individual ways. Over the next 27 years, Kerkar built up IHCL as India's largest and most

profitable hospitality company. In the 1970s, IHCL expanded in a major way in Delhi, Madras, Goa

and Rajasthan. This was seen as a major achievement for Kerkar as he succeeded despite very

little financial help from the Tatas. By the 1980s, the once sick hotel had turned into a chain

embracing the US and Europe. Kerkar funded the expansion of the IHCL flagship Taj Hotel by

floating different companies, with different partners.

Kerkar pioneered the concept of an's palace hotels and resort hotels of Goa. He enhanced India's

status as a tourist attraction by developing Rajasthan and Goa as tourist destinations. Kerkar had

a well-polished public image and established himself as a capable executive.

He was regarded as the man who almost single-handedly converted a one-hotel company into a

thriving hotel chain with an international presence. Ultimately however, the Kerkar era came to an

end on August 30, 1997, not with canape and champagne, but with anger and acrimony.

The negative attitude of the Tatas toward the hotel business forced Kerkar to raise funds in his

private capacity. Kerkar took the help of a group of investors, including the biscuit and cashew

millionaire Rajan Pillai, for the Goa venture. The Tatas had just 6% of the equity in the venture.

The Taj in Chennai and the Malabar Hotel in Kerala were built with the help of another group of

investors. Kerkar later claimed that from the very beginning he wanted all the companies

belonging to the Tata group to take large stakes in each of the hotels so that they remained

forever secure as Tata entities.

In the 1980s, Kerkar used the same financial strategy that he followed in India to set up hotels in

the UK and the US. These complex financing arrangements resulted in many companies with

interconnected loans and exposures, and minimized the equity control of IHCL and the Tatas over

the Taj group. It also became one of the major charges against Kerkar's corporate governance.

The Tatas blamed Kerkar for FERA violations in the agreement between IHCL and Singapore

Airlines for the latter's office in the Taj Mahal Hotel in Mumbai. According to the Tatas, IHCL

management directed Singapore Airlines, to pay security deposits amounting to $4.91 million to

Taj International Hotels Hong Kong Ltd., instead of receiving the money directly in India. For more

than three and a half years, the management kept this money overseas without the knowledge

and approval of the board and the statutory authorities

The transaction came to light after Ratan Tata received a letter from Singapore Airlines requesting

for a 10% reduction in the deposit asked for by the Taj. However, Kerkar strongly refuted this

allegation. Kerkar said that the money was paid to Taj Hong Kong only as ample measure of

security, since there were several cases of entities who leased in premises and did not vacate

them. Kerkar was also alleged to have laundered money to help Cox & Kings (UK) to finance its

acquisition of 40% stake in Cox & Kings (India) HYPERLINK "http://www.icmrindia.org/casestudies/catalogue/Business

%20Ethics/Indian%20Hotels%20Controversy.htm" \l "bot 1#bot 1" 1 by Anthony Good HYPERLINK

"http://www.icmrindia.org/casestudies/catalogue/Business%20Ethics/Indian%20Hotels%20Controversy.htm" \l "bot 2#bot 2" 2 . Good was a British

national and a close associate of Ajit Kerkar. Good was also associated with Good Relations India

Ltd., a public relations firm wholly owned and promoted by Cox & Kings.

It was also alleged that Cox & Kings was actually controlled by Kerkar's son, Peter Kerkar; Good

merely acted as a conduit for the funds to enable the takeover of Cox & Kings (India). Moreover,

Peter was a 50% beneficiary of the 40% stake acquired by Good.

However, Kerkar maintained that the acquisition of shares by Cox & Kings (UK) did not involve

any cash dealings. The stake was allotted to Cox & Kings (UK) company in consideration of

transfer of the Indian business of the company to Cox & Kings (India)

The End of the Kerkar Era

Kerkar's troubles started when Ratan Tata took over as the head of the Tata Empire. Unlike his

father JRD Tata, Ratan Tata proved to be less trusting of his managers. As the Tatas had never

helped Kerkar in any way - financial or otherwise, Kerkar commented that he didn't need Ratan

Tata to start telling him how to run his business.

Later, Ratan Tata also came up with the rule that all the affiliates in his empire should pay a hefty

sum for using the Tata brand name, Kerkar didn't accept this ruling. Kerkar also refused to

incorporate the Tata name in the IHCL brand name. Following this, the Tatas were keen to replace

Kerkar.

To nominate Kerkar's successor, an IHCL board meeting was scheduled in the last week of

August, 1997, after which Kerkar was expected to continue as the non-executive chairman.

Kerkar decided to reject the post after the nominees from within the hotel - Camellia Panjabi and

Leonard Menezes - were given a raw deal.

However, Tata directors also decided to blow the whistle on Kerkar, by informing the RBI about

the alleged FERA violations by IHCL and Kerkar. After Kerkar's resignation, IHCL appointed the

Chartered Accountancy firms of N M Raiji & Co and Sahni Natrajan & Bahl to go through the Taj

group's transactions.

On February 9, 1998, the two companies submitted their reports to IHCL. The report listed at

least six serious FERA irregularities. It ended with a report on their scrutiny of board minutes

between 1994 and 1997 to check if the IHCL board was informed about the various acts of

omission and commission reported by the accountancy firms.

According to the report, except for a transaction pertaining to the securitisation of loans advanced

by the State Bank of India and Bank of India to St James Court Hotels Ltd., none of the other

issues had been brought to the board for consideration.

The six FERA irregularities includes: -

An amount of $0.5 million advanced to one Salim Assiyabi

Payment of $4,63,076 in favor of Conil Investment & Trade Inc part of this money was diverted to

J Henry Schroders Bank for the purchase of GDRs of Oriental Hotels Ltd. This was allegedly not

reflected in the Indian Hotels books "with some help through false certificates obtained form J

Henry Schroders Bank";

Transfer of $2 million in the account of Piem Hong Kong, with a shortfall in the subsequent refund

of that amount;

The creation of security of Indian assets for an overseas loan taken for St James Court from State

Bank and Bank of India

Acquisition of Cedar Bay Trading Ltd. a single share bearer company by Taj Honk Kong to park the

GDRs mentioned above;

Diversion of funds to Cox & Kings and investments by Piem Hotels Ltd in Piem Hong Kong and

investment by Oriental Hotels Ltd in Oriental Hotels Hong Kong...

Case Study II

FERA Violation by ITC

Abstract:

The case examines the charges of FERA violations against tobacco major ITC in the 1990s. The

case details the dubious international trading deals by ITC and its partners, the Chitalias, the

Enforcement Directorate's investigations and the arrests of ITC executives.

The case also looks at charges of excise duty evasion and share price manipulation against ITC.

The case ends with a discussion on the measures taken by the company to restore its corporate

image in the light of various charges.

Issues:

» Corporate governance structure and causes that led to unethical behavior in a large company

engaged in international business

Keywords:

FERA, tobacco, ITC,1990,dubious international trading deals, ITC, Chitalias, Enforcement,

directorate, ITC executives, excise duty evasion, share price manipulation, corporate image.

“It is extremely disgusting to see what is happening to Chugh and Sapru today."

- S.L. Rao, Former Director, National Council of Applied Economic Research, commenting

on the arrests of former ITC Chairmen, in November 1996.

ITC in Trouble

In October 1996, officials of the Enforcement Directorate HYPERLINK "http://www.icmrindia.org/CaseStudies/catalogue/Business

%20Ethics/ITC%20The%20FERA%20Violation%20Story.htm" \l "bot1#bot1" 1(ED), Customs and Department of Revenue

Intelligence (DRI) conducted raids on the various establishments of tobacco to hotels major ITC in

Kolkata. The raids were conducted because the ED suspected ITC of having contravened FERA

regulations HYPERLINK "http://www.icmrindia.org/CaseStudies/catalogue/Business%20Ethics/ITC%20The%20FERA%20Violation%20Story.htm" \l "bot2#bot2" 2

to the tune of $100 million.

ED sources claimed to have found conclusive documentary evidence of FERA violations by ITC

from the raids. Following this, on October 30th, 1996, ED officials arrested R. K. Kutty, Director

and head of ITC subsidiary International Business Division (IBD), G. K. P. Reddi, former IBD

Director and Chairman, E. Ravindranath, former IBD Vice-President, Operations, IBD, and M. B.

Rao, former export manager, IBD.

The arrests were made under section 35 of FERA, to conduct interrogations on FERA violations by

ITC in international trading deals during 1991-95. All the arrested officials were remanded to

judicial custody until November 13th, 1996 On 31st October 1996, former Chairmen of ITC Ltd.

(ITC), J.N. Sapru (Sapru) and Krishen Lal Chugh (Chugh) were summoned to the ED's office in

Kolkata for interrogation. They were arrested the same day. On November 5, 1996, the ED

interrogated ITC Chairman, Y.C. Deveshwar, who promised to submit a complete report on

alleged FERA violations. By mid November, the ED arrested a few more ITC executives taking the

total number of arrested officials to 15.

By June 1997, ITC's board of directors was facing prosecution on account of allegations of FERA

contravention. An ED official said, "For the first time in Indian corporate history, the entire board

of directors of a company has been held liable for irregularities." The case attracted extensive

media attention, resulting in serious debates regarding the stringent FERA regulations and the

need for efficient corporate governance practices in companies. The issue was discussed in both

the houses of parliament, where MPs accused ITC of poor corporate governance practices and lack

of transparency. The MPs wanted the DCA HYPERLINK "http://www.icmrindia.org/CaseStudies/catalogue/Business%20Ethics/ITC%20The

%20FERA%20Violation%20Story.htm" \l "bot3#bot3" 3 to investigate into the matter, as they felt ITC had contravened

various sections of the companies Act and willfully and deliberately misinterpreted information

causing loss to the shareholders

Though ITC performed very well on the financial front for the fiscal 1996-97, charges of FERA

violation, excise duty evasion and share price manipulation in the early 1990s seemed to have

tarnished the company's image beyond repair.

Background Note

ITC was started by UK-based tobacco major BAT. It was called the Peninsular Tobacco Company

(Peninsular), for cigarette manufacturing, tobacco procurement and processing activities. In 1910,

it set up a full-fledged sales organization named the Imperial Tobacco Company of India Limited

(Imperial). To cope with the growing demand, BAT set up another cigarette manufacturing unit in

Bangalore in 1912. To handle the raw material (tobacco leaf) requirements, a new company called

Indian Leaf Tobacco Company (ILTC) was incorporated in July 1912. By 1919, BAT had

transferred its holdings in Peninsular and ILTC to Imperial. Following this, Imperial replaced

Peninsular as BAT's main subsidiary in India.

By the late 1960s, the Indian government began putting pressure on multinational companies to

reduce their holdings. Imperial divested its equity in 1969 through a public offer, which raised the

shareholdings of Indian individual and institutional investors from 6.6% to 26%.

After this, the holdings of Indian financial institutions were 38% and the foreign collaborator held

36%. Though Imperial clearly dominated the cigarette business, it soon realized that making only

a single product, especially one that was considered injurious to health, could become a problem.

In addition, regular increases in excise duty on cigarettes started having a negative impact on the

company's profitability. To reduce its dependence on the cigarette and tobacco business, Imperial

decided to diversify into new businesses. It set up a marine products export division in 1971. The

company's name was changed to ITC Ltd. (ITC) in 1974. In the same year, ITC reorganized itself

and emerged as a new organization divided along product lines

The Allegations

A majority of ITC's legal troubles could be traced back to its association with the US based Suresh

Chitalia and Devang Chitalia (Chitalias). The Chitalias were ITC's trading partners in its

international trading business and were also directors of ITC International, the international

trading subsidiary of ITC.

In 1989, ITC started the 'Bukhara' chain of restaurants in the US, jointly with its subsidiary ITC

International and some Non-Resident Indian (NRI) doctors. Though the venture ran into huge

losses, ITC decided to make good the losses and honour its commitment of providing a 25%

return on the investments to the NRI doctors.

ITC sought Chitalias' help for this. According to the deal, the Chitalias later bought the Bukhara

venture in 1990 for around $1 million. Investors were paid off through the Chitalias New-Jersey

based company, ETS Fibers, which supplied waste paper to ITC Bhadrachalam...

FERA Violations

The ED found out that around $ 83 million was transferred into India as per ITC's instructions on

the basis of the accounts maintained by the Chitalia group of companies. According to the ED

officials, the ITC management gave daily instructions to manipulate the invoices related to exports

in order to post artificial profits in its books

A sum of $ 6.5 million was transferred from ITC Global to the Chitalias' companies and the same

was remitted to ITC at a later date. Another instance cited of money laundering by ITC was

regarding the over-invoicing of machinery imported by ITC Bhadrachalam Paperboards Ltd., from

Italy.

The difference in amount was retained abroad and then passed to the Chitalias, which was

eventually remitted to ITC. The ED issued chargesheets to a few top executives of ITC and raided

on nearly 40 ITC offices including the premises of its top executives in Kolkata, Delhi, Hyderabad,

Guntur, Chennai and Mumbai...

The Aftermath - Setting Things Right

Alarmed by the growing criticism of its corporate governance practices and the legal problems,

ITC took some drastic steps in its board meeting held on November 15, 1996. ITC inducted three

independent, non-executive directors on the Board and repealed the executive powers of Saurabh

Misra, ITC deputy chairman, Feroze Vevaina, finance chief and R.K. Kutty, director.

ITC also suspended the powers of the Committee of Directors and appointed an interim

management committee. This committee was headed by the Chairman and included chief

executives of the main businesses to run the day-to-day affairs of the company until the company

had a new corporate governance structure in place. ITC also appointed a chief vigilance officer

(CVO) for the ITC group, who reported independently to the board. ITC restructured its

management and corporate governance practices in early 1997. The new management structure

comprised three tiers- the Board of Directors (BOD), the Core Management Committee (CMC) and

the Divisional Management Committee (DMC), which were responsible for strategic supervision,

strategic management, and executive management in the company respectively...

Conclusion

As a part of the on going process of economic liberalization relating to foreign investments and

foreign trade in India and as a measure for closer interaction with the world economy the Foreign

Exchange Regulation Act, 1973 (FERA) was reviewed in the year 1993 and several amendments

were made therein. Further review of the FERA was undertaken by the Central Government of

India in the light of subsequent developments and on account of the experience in relation to

foreign trade and investment in India, the Central Government felt that instead of further

amending the FERA, the better course would be to repeal the existing Act and to enact a new

legislation in its place. In view of the same, the RBI was asked to suggest a new legislation based

on the report submitted by a task force constituted for this purpose by the RBI recommending

substantial changes in FERA. There has been a substantial increase in the Foreign Exchange

Reserves of India. Especially after repulsion of FERA in 2000 there has been a tremendous surge

in Foreign Exchange Reserves.

INCLUDEPICTURE "http://www.rbi.org.in/scripts/images/78800_ch1.gif" \*

MERGEFORMATINET

Since the year 1993, Foreign trade has grown up. Development has taken place such as current

account convertibility, liberalization in investments abroad, increased access to external

commercial borrowings by Indian Companies and participation by foreign institutional investors in

securities markets in India. Keeping in view these changes the Central Government of India has

introduced the FEMA to repeal FERA. A marked digression from the general rule that the Accused

is presumed to be innocent until proved guilty beyond reasonable doubt, is found in the FEMA. A

presumption regarding documents, contained in this Bill is contrary to the general rules of

evidence.

For example, when documents pertaining to a crime under FEMA are discovered the Court will

presume that the contents of the documents are true and correct and will not go into the question

whether the incriminating documents may have been forged. Thus, it becomes the responsibility

of the Accused to prove, in case that the documents are fabricated. The main change between

FERA and FEMA is in the approach. FERA seeks to regulate almost all the transactions involving

foreign exchange and inbound/outbound investments. In FERA every provision is restrictive and

starts with a negative proposition stating that whatever is mentioned in that section is prohibited

unless the prior permission either general or special, as may be required in the specific case, of

RBI is obtained. FERA provides that nothing can be done without RBI's permission. In comparison

to this existing negative piece of legislation, the provision of FEMA has a positive approach. This

can be found from the provisions of FEMA dealing with capital account transactions which are to

be regulated. Unlike FERA which provides that these transactions cannot be entered into without

prior permission of RBI, FEMA provides that any person may sell or draw foreign exchange for

such transactions and then specifies the powers of the RBI to regulate the class or limits of such

capital account transactions. Thus the basic proposition in the proposed FEMA Bill is positive.

FEMA classifies foreign exchange transactions into capital account transactions and current

account transactions and amongst the two regulates the former more closely. Under FEMA

residential status will not depend upon the intent of the person to reside in India but would

depend upon the exact period of his stay in India.The provisions of the FEMA Bill aims at

consolidating and amending the law relating to foreign exchange with the object of facilitating

external trade and payments and for promoting the orderly payment and amendments in foreign

exchange markets in India. The FEMA Bill empowers the RBI to authorize persons to deal in

foreign securities specifying the conditions for the same. It also provides for a person resident in

India in holding, owning, transferring or investing in foreign security and for a person resident out

side India in holding, owning, transferring or investing in Indian Securities.

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