FinTechAnalysing FEMA Compliance: Key Highlights of the New Compounding Rules, 2024

INTRODUCTION

On September 12, 2024, the Ministry of Finance, in consultation with the Reserve Bank of India (hereinafter referred to as “RBI”), introduced the Foreign Exchange (Compounding Proceedings) Rules, 2024 (hereinafter referred to as “Compounding Rules”). These rules replace the previous Foreign Exchange (Compounding Proceedings) Rules, 2000 (hereinafter referred to as “Erstwhile Compounding Rules”). The RBI followed this up with the notification of the Compounding Directions on October 1, 2024, and outlines the procedures for compounding contraventions under the Foreign Exchange Management Act, 1999 (hereinafter referred to as “FEMA”).

The Compounding Rules became effective from September 12, 2024. Any pending compounding applications will continue to be processed under the Erstwhile Compounding Rules. The new rules aim to improve compliance and speed up the resolution of technical or administrative issues. They simplify the compounding application process, introduce digital payment options for fees, and provide clearer descriptions of contraventions. Additionally, the Compounding Rules revise fees based on the severity of the violation.

COMPOUNDING UNDER FEMA

Compounding is the process through which an individual or company voluntarily admits to violating FEMA provisions, pleads guilty, and seeks resolution under the Compounding Rules from the designated authority. To proceed with compounding, it is essential to regularize or rectify any past non-compliance. Compounding allows for the transparent and timely resolution of admitted breaches.

When a person violates any provision of FEMA or its associated rules, regulations, notifications, or orders, they have the option to apply for compounding, either voluntarily or after receiving a Memorandum of Contravention from the RBI. Violations can include failing to file statutory forms or not obtaining necessary approvals for cross-border transactions. Before submitting a compounding application, the applicant must confirm that they have not compounded any violations in the last three years. If a contravention is compounded, any future offence after three years is considered the first violation.

Additionally, compounding cannot be done through RBI if the violation amount is unquantifiable or if the breach relates to sensitive issues under Section 3(a) of FEMA, such as money laundering, terror financing, or threats to national sovereignty and integrity. These conditions ensure that the compounding process is not misused for serious regulatory violations.

As a result, both companies and regulators view the FEMA compounding mechanism as an effective tool for addressing foreign exchange violations without lengthy proceedings, especially in cases of inadvertent non-compliance or delays. Once a contravention is compounded and the order is followed, no further proceedings can be initiated or continued regarding that specific violation.

KEY FEATURES OF THE 2024 COMPOUNDING RULES

Under the Compounding Rules, the compounding authority can be either from the RBI or the Directorate of Enforcement (hereinafter referred to as “ED”). In RBI, the authority is an officer not below the rank of Assistant General Manager, while in the ED, the authority is an officer not below the rank of Deputy Director.

When reviewing the application, the compounding authority takes into account various factors such as any undue gains from the violation, the loss to the authority, the nature of the contravention, and the applicant’s track record and conduct during the transaction. Based on this assessment, the compounding authority issues the compounding order. This order must be passed within 180 days from the date the application is made.

The maximum compounding amount can be up to three times the value of the contravention. Additionally, a further penalty of up to Rs. 5,000 per day may be imposed for each day the contravention continues beyond the first day.

OLD v. NEW RULES: WHAT HAS CHANGED?

The Compounding Rules and Compounding Directions bring in procedural changes to the previous compounding process. Previously, applicants had to submit physical applications for compounding; however, now they can submit their applications either physically or through the RBI’s PRAVAAH portal, along with the prescribed fee. The fee for filing a compounding application has been increased from INR 5,000 to INR 10,000, with the addition of electronic or online payment options. The online payment option is also available for paying the compounding penalty, which must be paid within 15 days of receiving the compounding order. Under the earlier rules, the payment could only be made via demand draft.

Under the Erstwhile Compounding Rules, the compounding authority could request any information, records, or documents related to the contravention. Now, the authority can also direct the applicant to take necessary actions regarding the transactions involved in the contravention.

The non-compoundable contraventions previously under Rule 8 of the Erstwhile Compounding Rules have been expanded and moved to Rule 9 of the Compounding Rules. These include violations where the amount is unquantifiable, where foreign exchange or foreign securities were acquired in violation of FEMA, or where the ED considers the contravention to be serious, such as money laundering or terror financing. Additionally, the Compounding Rules address situations where the adjudicating authority has imposed a penalty under FEMA or where the compounding authority believes further investigation by the ED is necessary to determine the amount involved under Section 13.

Another major change in the Compounding Rules is the revision of the monetary threshold for determining the compounding authority based on the sums involved in the contravention. The new rules outline this distinction, with a detailed snapshot provided in the table below:

AMLEGALS REMARKS

The overhaul of the foreign exchange regulatory framework is expected to enhance the efficiency and speed of the compounding process. While the Compounding Rules and Compounding Directions aim to streamline this process, there may still be areas where further improvements are needed to fully achieve the intended goals of these amendments. One key area for improvement is the 180-days timeline for resolving compounding applications, which remains in place under the new rules. This timeline could be further reduced, particularly for administrative or technical matters, to speed up the resolution of contraventions under FEMA. A potential solution could be to establish a dedicated department that categorizes applications based on the nature of the contravention, allowing simpler cases to be handled quickly.

Although the Compounding Rules offer the option to file applications through the online portal, it has not been made mandatory. This leaves room for confusion and the possibility of multiple processes, which can hinder the overall efficiency of the compounding system. By making online filing compulsory, as the DPIIT has done for FDI-related proposals, the process could be simplified and expedited, ensuring that applicants use a single, streamlined portal. Additionally, the Compounding Rules include a three-year ‘cooling-off’ period before a similar contravention can be compounded. To avoid ambiguity and inconsistent interpretations, it would be beneficial to establish clear, objective criteria for defining ‘similar contravention.’ This would help prevent situations where parties mistakenly assume a contravention is similar when it may not be, ensuring that all breaches are appropriately addressed.

– Team AMLEGALS assisted by Ms. Neha Katariya (Intern)

For any queries or feedback, feel free to connect to mridusha.guha@amlegals.com or liza.vanjani@amlegals.com