Under the Foreign Exchange Management Act (F FEMA), 1999, transactions involving the movement of capital into or out of India are classified as Capital Account Transactions (CAT). These transactions relate to investments, loans, borrowings, and other activities that affect a country’s capital account and overall financial position. They are different from Current Account Transactions (CAT), which mainly deal with day-to-day trade, services, and personal remittances.

1. Definition of Capital Account Transactions

Capital Account Transactions (CAT) are defined under FEMA as transactions that involve:

• Borrowing and lending: Either by Indian residents or non-residents.
• Acquisition or transfer of property: Involving non-residents, such as the purchase or sale of real estate or shares.
• Investment activities: Foreign investments, including both foreign direct investment (FDI) and foreign portfolio investment (FPI).
• Transfer of ownership of assets: That involves cross-border transfer of capital in the form of equity, debt, or other financial instruments.

These transactions generally influence the country’s balance of payments and affect the capital flow into or out of the country.

2. Categories of Capital Account Transactions

Some common examples of capital account transactions include:

a. Foreign Direct Investment (FDI)

• Inbound FDI: Foreign companies or individuals investing in Indian companies by purchasing equity or providing capital.
• Outbound FDI: Indian companies investing abroad by purchasing shares, assets, or establishing operations overseas.

b. Foreign Portfolio Investment (FPI)

• Investments in the equity or debt markets by foreign investors. These investments are typically short-term, with foreign investors buying and selling shares or bonds in India.

c. Loans and Borrowings

• External Commercial Borrowings (ECBs): Borrowing by Indian entities from foreign lenders.
• Non-resident External (NRE) and Non-resident Ordinary (NRO) accounts: Borrowings and repatriations to and from India.
• Overseas Borrowings: Indian companies taking loans from foreign banks or financial institutions.

d. Acquisition and Transfer of Property

• Real Estate Transactions: Non-residents purchasing or selling property in India or vice versa.
• Transfer of Securities: Transactions involving the purchase and sale of shares, bonds, or other securities by non-residents.

e. Repatriation of Profits and Dividends

• Non-resident investors repatriating dividends or capital gains earned from their investments in Indian companies back to their country of residence.

f. Other Capital Transactions

• Investment in financial instruments: Non-residents buying bonds, derivatives, or other securities issued by Indian entities.
• Gift or Inheritance of Assets: Transfer of capital by gifting or inheritance involving cross-border movement of assets.

3. Capital Account Transactions: Regulations Under FEMA

Under FEMA, capital account transactions are generally prohibited unless specifically permitted by the Reserve Bank of India (RBI). The RBI lays down rules for capital account convertibility, determining when capital transactions can be freely made and when approval is needed.

a. Restrictions on Capital Account Transactions

Capital account transactions may be restricted in the following cases:

• Real estate transactions involving foreign investments are subject to certain limits and restrictions.
• External Commercial Borrowings (ECBs): RBI sets limits and guidelines for Indian companies borrowing from foreign sources to ensure that they do not over-leverage.
• Foreign investments in specific sectors: Some sectors in India may have restrictions on foreign investment, including defense, agriculture, and retail.

b. RBI’s Role

• FEMA Guidelines: The RBI provides specific guidelines for capital account transactions. Foreign investments and borrowings are controlled by the RBI’s policies, including limits on FDI and FPI, and the approval process for external loans.
• RBI Approval: Certain transactions, such as outward remittances or investments by Indian residents in foreign assets, may require prior approval from the RBI, especially if they exceed specific monetary limits.

c. Monitoring of Capital Transactions

To maintain economic stability and prevent abuse of foreign exchange regulations, the RBI monitors and regulates capital account transactions using:

• FEMA Return Forms: Various forms such as FIRMS (Foreign Investment Reporting and Management System) and FIRC (Foreign Inward Remittance Certificate) are used for reporting capital account transactions.
• Reporting Obligations: Entities engaging in capital account transactions must report to the RBI or authorized dealers, such as banks and financial institutions, regarding investments, borrowings, or transfers.

4. Current Regulations for Capital Account Transactions

Some of the key FEMA regulations relating to capital account transactions are as follows:

• FEMA 120/2000-RB: This regulation governs foreign investment, including FDI, foreign borrowings, and the repatriation of capital.
• FEMA 23/2000: This regulation covers the rules related to foreign exchange transactions concerning investments in property (including real estate) and securities.

Other regulations that govern the flow of capital across borders include:

• External Commercial Borrowings (ECB) Guidelines: The RBI provides guidelines for Indian entities wishing to borrow money from international markets (foreign loans).
• FDI and FPI Guidelines: The government and RBI have set up specific limits and conditions under which FDI and FPI are allowed into India.
• Outward Remittances: Individuals or entities seeking to remit capital (e.g., for investments or loans abroad) must comply with the RBI’s Liberalized Remittance Scheme (LRS), which has a limit of USD 250,000 per year for individuals.

5. Capital Account Transactions and Repatriation

One of the key features of capital account transactions is the repatriation of capital, including:

• Repatriation of Investments: Non-residents can repatriate profits, capital gains, and dividends earned in India, subject to taxes and compliance with FEMA guidelines.
• Repatriation by Indian Residents: Indian residents wishing to transfer capital abroad for investment purposes (such as foreign direct investment or portfolio investment) must adhere to RBI regulations under FEMA and the Liberalized Remittance Scheme (LRS).

Key Repatriation Guidelines:

• Non-Residents: Foreign investors can remit their capital along with returns (profits, interest, dividends) to their home country after paying applicable taxes in India.
• Indian Residents: Indian individuals and entities can remit funds for investment abroad, subject to limits set by the RBI under LRS.

6. Taxation of Capital Account Transactions

Capital account transactions involving cross-border investments are subject to various taxes in India, such as:

• Income Tax: Income arising from capital account transactions like interest, dividends, capital gains, etc., is subject to Indian income tax. Capital gains tax applies to profits made on the sale of assets like shares, securities, or real estate.
• Withholding Tax: Payments to non-residents (such as interest, dividends, royalties) are subject to withholding tax as per the Income Tax Act.
• Double Taxation Avoidance Agreement (DTAA): India has signed DTAA agreements with several countries to avoid double taxation on income arising from capital account transactions.

7. Types of Capital Account Transactions Requiring RBI Approval

While most capital account transactions are allowed under FEMA, the following types require prior approval from the RBI:

• Investments in real estate (land or property) by foreign nationals or foreign companies.
• External Commercial Borrowings exceeding certain thresholds.
• Investments by Indian residents in foreign entities or securities.
• Loans exceeding specific limits set by the RBI.

8. Key Compliance Requirements for Capital Account Transactions

• Adherence to FEMA: Any capital account transaction must comply with the guidelines and regulations outlined in FEMA and its related rules.
• Reporting: Transactions must be reported to the RBI through appropriate forms, including FIRC and ECB return forms.
• Tax Compliance: Capital account transactions must adhere to taxation laws, including capital gains tax and withholding taxes.

Conclusion

Capital account transactions involve the movement of capital, such as investments, loans, and the purchase/sale of property or securities, across borders. These transactions are subject to various regulations under FEMA, RBI guidelines, and tax laws. The key difference between capital account transactions and current account transactions lies in the nature of the transaction: capital account transactions are related to long-term investments, loans, and acquisitions, whereas current account transactions are related to day-to-day trade and services.

For businesses or individuals engaging in capital account transactions, it is essential to comply with FEMA regulations, seek necessary approvals from the RBI, and ensure proper tax filings.