Round Tripping of Funds: FEMA Limits, PMLA Exposure and How Courts Look Through Offshore Structures
This article explains how funds that leave India and return as foreign investment are treated under the Foreign Exchange Management Act, 1999 (FEMA) and the Prevention of Money-laundering Act, 2002 (PMLA), and how the Supreme Court and the Bombay High Court have approached such structures.
It matters now because inbound investment routed through Mauritius, Singapore or the British Virgin Islands is routinely examined by the Reserve Bank of India, the Enforcement Directorate and the tax department. A practitioner advising on an overseas holding structure, or on an FDI inflow with an Indian origin, needs to know where regulatory exposure begins.
The issue
Round tripping describes a circular movement: money originating in India is sent to an offshore entity, often a company, trust or partnership formed outside the owner's primary country of residence or business, and then returns to India as investment that is presented as foreign direct investment. Some of the vehicles used are shell companies, which exist on paper with no significant assets or active business.
Two motives are commonly attributed to such arrangements:
- obtaining benefits under a double taxation avoidance agreement (
DTAA), that is, a bilateral treaty meant to prevent the same income being taxed in both the residence and the source country; and - bringing undisclosed money back into the formal economy under the appearance of foreign capital.
The first motive raises treaty-entitlement questions; the second raises both exchange-control and money-laundering questions.
Governing law under FEMA
Section 3, FEMA
Section 3 requires dealings in foreign exchange to conform to the Act and the rules and regulations made under it. Clause (d) of Section 3 bars entering into a financial transaction in India as consideration for, or in association with, the acquisition, creation or transfer of a right to acquire an asset outside India. Where an Indian resident funds an offshore vehicle and the vehicle later invests back, the first leg of the arrangement can fall within this prohibition unless it is permitted by the regulatory framework.