Compounding under FEMA has traditionally been the practical mechanism for businesses, startups, NRIs, funds, and multinational groups to voluntarily settle foreign exchange contraventions. But with the Foreign Exchange Management (Compounding Proceedings) Rules, 2024, updated RBI Master Directions, and recent judicial interventions, the environment has changed dramatically.
What was once an administrative cure is now a structured compliance test, backed by data analytics, cross-regulator collaboration, and a clearly defined list of ineligible contraventions. As someone who regularly advises on FEMA issues, I can say with certainty: compounding is still a powerful remedy — but it is no longer the easy fallback it used to be.
1. Statutory Basis of Compounding
Compounding under FEMA is rooted in Section 15 of FEMA, 1999, which permits settlement of contraventions — except those punishable under Section 13(1C) (serious offences involving money laundering, terrorism financing, etc.).
Three regulatory layers govern the modern compounding framework:
(a) Foreign Exchange Management (Compounding Proceedings) Rules, 2024
Notified under FEMA Section 46, these Rules replaced the two-decade-old 2000 Rules and introduced a sharper, graded structure.
Key provisions that matter in practice:
Rule 4 — Authority for Compounding
- RBI compounds all contraventions except those involving hawala, money laundering, national security, or criminality, which remain with the Enforcement Directorate.
- Monetary slabs now determine whether an AGM, DGM, GM or CGM compounds the matter.
Rule 5 — Application
- Applications are filed electronically in prescribed form.
Rule 8 — Finality
- RBI must dispose of the matter within 180 days.
- Once compounded, no further proceeding shall be initiated or continued for the same contravention.
Rule 9 — Ineligible Cases
Compounding is not permitted where:
- Amount not quantifiable
- The case involves national security risks
- A similar contravention occurred in the last 3 years
- The matter involves fraud, wilful violation, or active criminal investigation
- The matter needs further investigation by ED
This is a major shift — compounding is no longer automatically available
(b) RBI Master Direction — Compounding of Contraventions under FEMA (Updated 2024–25)
The Master Direction operationalises the Rules and provides RBI’s approach to quantifying penalties.
- What RBI handles
Including but not limited to:
- FDI contraventions (FC-GPR, FC-TRS, LLP filings, pricing errors)
- ODI contraventions (Form FC, APR, financial commitment, SDE issues)
- ECB, Branch Office, Liaison Office non-compliances
- Formula-based compounding amounts
The 2024 framework introduced transparent penalty matrices, for example:
- Delayed reporting
₹10,000 fixed + ₹1,000 to ₹2,00,000 per year (value-based slab) - Delayed allotment/refund
₹30,000 fixed + 0.30% to 0.75% of amount involved - Guarantee violations
₹5,00,000 fixed + 0.05% to 0.075% per year - Valuation breaches
Penalty linked to extent of undervaluation or overvaluation
- Principle of proportionality
- Procedural lapses → lower penalties
- Substantive violations (round-tripping, unauthorized structures, disguised debt) → heavy scrutiny
- “One Opportunity” Rule
If the applicant fails to provide all documents sought by RBI, the application can be rejected outright.
2. High-risk Triggers for Compounding
- NDI Rules, 2019 / FEMA 20(R) — FDI, ESOPs, pricing, reporting
- ODI Rules & Regulations, 2022 — overseas subsidiaries, guarantees, step-down entities
- Borrowing and Lending Regulations — ECB, intercompany loans
- Current Account Rules, 2000 — LRS misuse, crypto transactions
- Immovable Property Regulations — agricultural land restrictions for NRIs
Compounding is a remedy — but not a substitute for compliance under these core regulations.
3. Regulatory & Enforcement Trends — The 2025 Reality
a) Contraventions are being flagged much earlier
Banks now run automated checks across:
- FIRC / SWIFT
- FC-GPR vs FIRMS filings
- ODI APR vs financial commitment
- Purpose codes vs underlying invoices
- Income-tax disclosures (FA schedule, Form 67)
This cross-dataset matching has effectively ended the era where reporting violations remained undetected for years.
b) ODI regime = tighter scrutiny
Under the ODI framework, RBI is now examining:
- Whether structures result in round-tripping
- Whether “control” exists under Rule 2(j)
- Whether guarantees were issued without equity participation
- Whether step-down subsidiaries comply with host-country regulations
ODI-related contraventions have become one of the largest buckets of compounding applications.
c) Crypto & LRS transactions flagged under FEMA Section 3
Even without a formal FEMA crypto framework, ED has treated:
- wallet-to-wallet transfers
- overseas exchange deposits
- crypto arbitrage using LRS funds
as unauthorized capital account transactions.
These matters often become non-compoundable, falling under ED’s remit.
4. Courts are redrawing the boundaries of compounding
Recent judicial trends show:
- Courts permit compounding during proceedings if fair and justified.
- Courts reject compounding after adjudication when final orders have attained finality.
- The Supreme Court has allowed compounding in exceptional cases involving purely procedural violations.
Bottom line:
Voluntary, early applications are respected; strategic delay is not.
5. Case Studies (anonymized) from recent compounding orders
Case a) Delayed FC-GPR by a Startup
- Issue: Allotment made but FC-GPR filed after 18 months
- Outcome: Formula-based penalty imposed
- Learning: FDI reporting timelines are strict and investors treat non-compliance as governance weakness.
Case b) ODI without Control + Step-Down Subsidiary Abroad
- Issue: Guarantees issued without equity participation; overseas SDE created
- Outcome: Higher compounding cost + mandatory unwinding
- Learning: Guarantees = financial commitment; ODI must follow formal structure, not organic business convenience.
Case c) Foreign Investor Share Transfer at Discount
- Issue: Transfer price below FMV under NDI Rules
- Outcome: Penalty linked to undervaluation
- Learning: Negotiated price cannot violate FEMA pricing norms.
Case d) NRI Acquiring Agricultural Land
- Issue: Sectoral prohibition
- Outcome: Compounded only after disposal of property
- Learning: Sectoral restrictions are enforced strictly, irrespective of intent.
6. Practical Tips:
(a) Build a FEMA-first Cap Table
Cap table must match FIRMS filings and bank documentation.
(b) Treat valuation as a regulatory requirement
As per acceptable valuation methodology DCF, NAV, Comparable methodology — not negotiation spreadsheets.
(c,) Automate your FEMA calendar
- FC-GPR – 30 days
- FC-TRS – 60 days
- ODI Form FC – before investment
- APR – annually
- ECB filings – monthly
(d) Document commercial substance
RBI increasingly asks:
“Why does this overseas structure exist?”
(e) Avoid LRS for crypto or grey-zone assets
These frequently fall into non-compoundable categories.
(f) Conduct annual FEMA health checks
Especially before fundraise, offshore expansion, or exit.
(g) If a contravention is discovered — act early
Compounding works best before adjudication and before ED involvement.
Conclusion:
Compounding remains a valuable, non-adversarial settlement mechanism.
But the 2024 Rules, updated RBI Directions, and evolving judicial doctrine send a single message:
India is moving toward a transparent, tech-enabled, documentation-heavy FEMA regime.
Compliance isn’t a cost anymore — it’s part of your credibility capital.
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In case you have any concern and queries or need any support under FEMA, FDI, ODI, GST and International Taxation, you may like to contact us.
Abhinarayan Mishra, FCA, FCS; Managing Partner, KPAM & Associates, Chartered Accountants, Dwarka, New Delhi; +9910744992, ca.abhimishra@gmail.com
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