FEMA Guidelines for Indian Startups: FDI, ECB, Remittances & Compliance

The Foreign Exchange Management Act (FEMA) lays out the rules for investments in Indian startups and for transactions involving foreign exchange. Guidelines for external commercial borrowings (ECB), trade-related remittances, foreign direct investment (FDI), and reporting compliance are all included in this.

1. Foreign Direct Investment, or FDI

1. FDI is the term used to describe the investments made in Indian startups and businesses by foreign entities or individuals.

2. FDI is a significant source of funding for Indian startups, giving them access to capital, worldwide markets, and technology.

3. FDI inflows are subject to FEMA regulations and may take the Government Route or the Automatic Route.

FDI Routes: Automatic & Govt Route

Automatic Route: No government approval required for most FDI up to 100% ownership.

Government Route: Mandatory approval from Indian government for FDI above certain sectoral caps.

The Automatic Route allows up to 100% FDI in most sectors without requiring government approval, providing a streamlined process for startups and investors.

The Government Route, on the other hand, mandates approval from the Indian government for FDI above certain sectoral caps, ensuring oversight and alignment with national priorities.

Procedures for Government Approval

File proposal for foreign investment, along with supporting documents, online on the Foreign Investment Facilitation Portal.

Govt Routes Approval Process

DPIIT (Department for Promotion of Industry and Internal Trade) reviews and circulates the proposal to relevant ministries. They provide comments within 4-6 weeks. Proposals over ₹50 billion go to the Cabinet Committee on Economic Affairs. Once the proposal is complete, the government provides final approval within 8–10 weeks. 

Prohibited Sectors for Foreign Investment in India

1. Lottery Business
2. Gambling and Betting
3. Chit Funds and Nidhi Companies
4. Real Estate

FEMA Reporting Requirements and Compliance for Startups

• Company Information
• CS certificate (Pre- and post-shareholding pattern)
• Financial Documentation
• Valuation certificate
• FIRC/debit statement
• Board resolution

Non-compliance with the filing requirements for Form FC-GPR can lead to significant consequences.

1. Penalties: The Reserve Bank of India (RBI) can impose a penalty of up to 2% of the issue amount for non-compliance with FC-GPR filing requirements.

2. Delays in Future Transactions: There may be delays in processing subsequent FDI transactions for the company.

3. Monetary Fines: The RBI may impose monetary fines, which can include: A fixed amount of INR 5,000.

• 1% of the total investment, which can go up to a maximum of INR 5 lakh.
• The penalty rate may double for every six-month delay beyond the initial period.

Annual Return on Foreign Liabilities and Assets (FLA Return)

• The FLA return is required for Indian companies, LLPs, and entities with FDI or ODI in the current or any previous year.
• Submission Deadline
• The Annual Return on Foreign Liabilities and Assets must be submitted by July 15th every year.
• Purpose
• This return helps assess India’s foreign assets and liabilities, contributing to the Balance of Payments (BoP) and International Investment Position (IIP) analysis.
• Non-Compliance
• Failure to file the return by the due date can lead to penalties under the FEMA regulations, though the specific amounts are not provided. 

2. ECB (External Commercial Borrowings) for Startups

ECB allows startups to access foreign capital for expansion, but they must comply with FEMA’s strict guidelines. Eligible sectors include infrastructure, manufacturing, and select services. Startups face a $3 million annual limit, while the overall ECB cap is $750 million per year.

ECB (External Commercial Borrowings) for Startups

Foreign Currency-Denominated ECB

Startups can borrow in foreign currency through ECB, including bank loans, bonds, and trade credits. Lenders must be residents of FATF- or IOSCO-compliant countries to be eligible.

INR-nominated ECB

Startups can also raise ECB in Indian Rupees, such as through rupee-nominated bonds (Masala Bonds). Infrastructure companies must meet a 10-year minimum average maturity requirement.

Eligible Borrowers

Entities like manufacturers, software companies, airlines, and micro-finance institutions are eligible to raise ECB. SEZ units and development banks can also access this funding.

Accessing ECB for Startups

Your startup should be a private firm or partnership under 10 years old with turnover below Rs. 100 crore, focusing on on innovation and growth.

Upon approval, the bank sends your application to the RBI, which issues a Loan Registration Number (LRN) for the ECB.

Borrowers must report actual External Commercial Borrowing (ECB) transactions using Form ECB 2 through authorized banks as specified by the RBI.

Late Submission Fees for ECB2

For startups reporting External Commercial Borrowings (ECB) late, the Reserve Bank of India (RBI) imposes a fixed Late Submission Fee (LSF) of INR 50,000 per year for up to three years from the due date of submission or drawdown. If the delay extends beyond three years, the LSF will increase to INR 1 lakh per year.

The LSF formula is [Rs. 7500 + (0.025% A n)], where n is the number of years of delay rounded up to the nearest month, and A is the amount involved in the delayed reporting. The maximum LSF is capped at 100% of the reported amount.

Startups have up to three years from the due date to pay the LSF. If unpaid within 30 days of the RBI’s advice, the LSF will be considered null and void, and any subsequent payments will not be accepted.

3. Remittances Under FEMA

Outward Remittances: Indian citizens can transfer up to $250,000 per year abroad for education, travel, or investment purposes. Transfers to certain countries and entities are prohibited, and special RBI permission is required to remit more than $250,000.

Inward Remittances: There is no limit for personal remittances under the Rupee Drawing Arrangement (RDA). The Money Transfer Service Scheme (MTSS) is capped at $2,500 per transaction, with a maximum of 30 transfers per year to one recipient. All remittances must be processed through authorized agents, who issue a Foreign Inward Remittance Certificate (FIRC).

Remittances, both outward and inward, are governed by the Foreign Exchange Management Act (FEMA) and the associated rules and regulations.

4. Foreign Exchange Management (Export of Goods & Services) Regulations, 2015

• Exporters must furnish a detailed declaration to the specified authority for all goods or software exported outside India, including the full export value or expected value if not yet ascertainable.
• Certain exports, such as trade samples, personal effects, and goods for military use, are exempt from the declaration requirement.
• Exporters are obligated to realize and repatriate the full export value of goods, software, or services to India within a specified period, typically nine months from the date of export.
• Authorised dealer banks can provide guidance on reporting requirements, due dates, and help exporters fulfill their periodic return filing obligations under the Foreign Exchange Management Act (FEMA). 

Advance Payment against Exports

• Exporters must ship the goods, including software, within one year of receiving the advance payment from a buyer outside India.
• The interest rate payable on the advance payment should not exceed the London Inter-Bank Offered Rate (LIBOR) plus 100 basis points.
• The documents covering the shipment must be routed through the AD Category-I bank that received the advance payment.

Periodic Return Filing Requirements under FEMA for Exporters

• Exporters must submit EDF within 21 days of the export date, providing details like invoice, buyer, quantity, value, and payment method.
• Exporters must submit GR forms for physical exports and PP forms for software/services within 21 days of shipment, detailing the transaction for monitoring.
• Exporters must obtain FIRC from their bank as proof of receiving foreign currency payment for exports.
• Exporters must obtain BRC from their bank, certifying the realization of export proceeds in foreign exchange.
• Exporters must submit regular returns through EDPMS or other channels, providing details on export transactions, proceeds realization, and outstanding bills.
• Exporters must submit statements detailing the status of outstanding export bills to monitor compliance with FEMA regulations.

Software Exports Reporting: Ensuring Compliance and Transparency

Software exports reporting is a key requirement under FEMA to ensure transparency, compliance, and accurate tracking of foreign exchange transactions related to software services and products exported from India.

Objectives

1. Regulatory Compliance: Adherence to FEMA regulations to prevent unauthorised transactions.
2. Foreign Exchange Control: Monitoring and controlling foreign exchange inflows and outflows.
3. Data Collection: Providing essential data for economic analysis and policy decisions.

Who’s Involved

• Software Exporters: Entities engaged in exporting software from India.
• Authorised Dealer Banks: Process foreign exchange transactions and ensure compliance.
• STPI: Verify and certify software exports statements.
• Reserve Bank of India: Oversee and regulate foreign exchange transactions.

Reporting of Software Exports to STPI

• Imports of goods and services are permitted under Section 5 of the FEMA. Regulations are communicated by the RBI through directions to authorized banks.
• The RBI issues master directions and circulars to guide authorized banks on implementing FEMA regulations for import transactions.
• DGFT regulates imports, while authorized banks ensure compliance with FEMA, FTP, and other applicable laws during import payments.
• Authorized banks must follow RBI rules on foreign exchange use, KYC, and obtaining necessary licenses for restricted imports.

5. Income Tax Reporting 15CA/CB – Payment to non-resident

• Form 15CA is required when making a payment to a non-resident that is subject to income tax. It serves as a declaration by the remitter and helps the Income Tax Department track foreign remittances and their tax liability.
• Form 15CB is a certificate from a Chartered Accountant required when the remittance or the aggregate of such remittances exceeds

Form 15CA must be filed before the remittance is made, while Form 15CB is required only when the remittance or aggregate exceeds ₹5 lakhs per fiscal year.

Consequences of Non-Compliance

Failure to file Forms 15CA and 15CB can lead to penalties and delays in the remittance process, highlighting the importance of adhering to these reporting requirements. 

6. Reporting and Compliance for Startups under FEMA (Snapshot)

Startups and SMEs with foreign investments must closely follow the FEMA (Foreign Exchange Management Act) guidelines set by the Reserve Bank of India. This includes reporting foreign liabilities and assets through the annual FLA Return, and following the Automatic or Approval routes for FDI (Foreign Direct Investment).

Startups can also raise up to $3 million through External Commercial Borrowings (ECBs) under FEMA regulations. Exporters must diligently declare exports and comply with rules around advance payments and periodic return filings.

Importers too have to abide by FEMA rules and guidelines from RBI and DGFT. Overall, comprehensive FEMA compliance is crucial for startups and SMEs engaging in cross-border transactions.

Reporting Requirement

1. FLA Return: Companies in India with foreign investments or assets must submit an annual FLA Return by July 15th. If there are no foreign investments or assets, no return is required.
2. APR: Indian entities or individuals who have invested abroad must submit an annual performance report by December 31st each year, which is usually certified by an auditor but can also be self- certified.
3. ECB: Companies with external commercial borrowings must report them monthly through an ‘ECB 2 Return’ form, detailing the outstanding amount, hedging, and cost.
4. Single Master Form: This consolidated report covers various foreign direct investment (FDI) transactions in India, with deadlines ranging from 30 to 60 days based on the type of transaction.
5. ARF: Companies receiving foreign investments must report the amount received within 30 days using the Advance Reporting Form.
6. Form FC-GPR: Companies issuing shares to foreign residents must report the issue within 30 days.
7. Form FC-TRS: Transfers of shares between residents and non-residents must be reported within 60 days.
8. Form ODI: Indian parties investing abroad must submit Form ODI and provide evidence of investment within 6 months. Sale proceeds from disinvestment must be brought back to India within 90 days.

Conclusion

Navigating FEMA regulations is essential for Indian startups to engage in cross-border transactions while ensuring compliance with legal requirements. Understanding FDI routes, ECB guidelines, remittance procedures, and reporting obligations is crucial for startups to thrive in India’s dynamic business landscape. By adhering to FEMA guidelines, startups can access foreign investments, expand their operations, and contribute to India’s economic growth while maintaining regulatory compliance.