CONTRAVENTION OF SECTION 5 OF THE FOREIGN EXCHANGE MANAGEMENT ACT, 1999

[DR.MARIAPPAN GOVINDARAJAN]

Section 5

Section 5 of the Foreign Exchange Management Act, 1999 (‘Act’ for short) provides that any person may sell or draw foreign exchange to or from an authorised person if such sale or drawal is a current account transaction.  The Central Government may, in public interest and in consultation with the Reserve Bank, impose such reasonable restrictions for current account transactions as may be prescribed.

Current Account transactions

The expression ‘current account transactions’ is defined under Section 2(j) of the Act as a transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes, -

• payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business,
• payments due as interest on loans and as net income from investments,
•  remittances for living expenses of parents, spouse and children residing abroad, and
• expenses in connection with foreign travel, education and medical care of parents, spouse and children.

Rule 4 of the Foreign Exchange Management (Current Account Transactions) Rules, 2000, provides that no person shall draw foreign exchange for a transaction included in the Schedule II without prior approval of the Government of India-

• Cultural Tours – approval by Ministry of Human Resource Development (Department of Education and Culture);
• Advertisement in foreign print media for the purposes other than promotion of tourism, foreign investments and international bidding (exceeding US$ 10,000) by a State Government and its Public Sector Undertakings – approval by Ministry of Finance, Department of Economic Affairs;
• Remittance of Freight of vessel chartered by a PSU – approval by Ministry of Shipping Transport, (Chartering Wing);
• Payment of import through ocean transport by a Government Department or a PSU on c.i.f. basis (i.e., other than f.o.b. and f.a.s. basis) – approval by Ministry of Shipping Transport, (Chartering Wing);
• Multi-modal transport operators making remittance to their agents abroad - Registration Certificate from the Director General of Shipping;
• Remittance of hiring charges of transponders by TV Channels and Internet Service Providers -  Ministry of Information and Broadcasting;
• Remittance of container detention charges exceeding the rate prescribed by Director General of Shipping - Ministry of Surface Transport (Director General of Shipping);
• Remittance of prize money/sponsorship of sports activity abroad by a person other than International/National/State Level sports bodies, if the amount involved exceeds US$ 1,00,000 - Ministry of Human Resource Development, (Department of Youth Affairs and Sports);
• Remittance for membership of P&I Club - Ministry of Finance (Insurance Division).

Contravention of Section 5

A person may be deemed to have contravened the provisions of Section 5 of the Act, if they-

• acquire or purchase foreign exchange for a purpose other than what was declared to an authorized person;
• do not use the foreign exchange for the declared purpose or surrender it to the authorized person within the specified period;
• use the foreign exchange for a purpose that is not permitted under the Act.

Penalty

Section 13(1) of the Act provides that if any person contravenes any provision of this Act, or contravenes any rule, regulation, notification, direction or order issued in exercise of the powers under this Act, or contravenes any condition subject to which an authorisation is issued by the Reserve Bank, he shall, upon adjudication, be liable to a penalty up to thrice the sum involved in such contravention where such amount is quantifiable, or up to Rs.2 lakhs where the amount is not quantifiable, and where such contravention is a continuing one, further penalty which may extend to Rs.5000/- for every day after the first day during which the contravention continues.

Case law

In UNION OF INDIA VERSUS QUESTNET ENTERPRISES INDIA PVT. LTD., MS. PUSHAP APPALA NAIDU - 2024 (12) TMI 1367 - APPELLATE TRIBUNAL UNDER SAFEMA AT NEW DELHI - Appellate Tribunal under SAFEMA, New Delhi, the Director of Enforcement initiated investigations against the respondent in the present appeal, under the Act on the basis of credible information that the foreign exchange was sent abroad by the said company.  A statement of the Managing Director of the respondent was recorded by the Enforcement Directorate.  In her statement she deposed that GoldQuest India Private Limited has started as subsidiary of GoldQuest International Private Limited, Hong Kong and registered in Chennai and having a branch office in Mumbai.  In the said statement, to the specific query about the financial transaction that had been taken place between the Indian company and Principal company at Hong Kong, she has stated that apart from the receipts from their parent company, on three occasions around Rs. 19 Crores were remitted to their parent company towards royalty.   She never furnished the details, as to the remittances and legal compliances.

The Auditor of the respondent company was also enquired.  The Auditor since 2003 submitted the report on the financial statements of the said companies. The royalty has been paid by Questnet to QI Limited Hong Kong for the technical services provided by it.  They have made the payments on 3 occasions to the tune of Rs. 19 Crores, towards remittance as Royalty to their parent company.  It is also ascertained that no permission in this regard has been obtained from the Government of India. 

The appellant observed that as the royalty remittances exceeded 5% of the local sales of the year 2007- 2008, Questnet Enterprises India Ltd, Chennai, ought to have obtained prior approval. The Enforcement Directorate alleged that the respondent remitted the amounts totalling to Rs. 15,68,88,739 as royalty to QI Limited, Hong Kong during the year 2007-2008, which were in excess of 5% of the local sales without obtaining approval of concerned Ministry of Government of India, and thereby contravened the provisions of Section 5 of FEMA, read with Rule 4 of the Foreign Exchange Management (Current Account Transactions) Rules, 2000, and rendered themselves liable to be proceeded for penalty under Section 13 of the Act.

A complaint dated 30.03.2017 was filed by the Assistant Director, Directorate of Enforcement, Chennai, before the then Adjudicating Authority viz. the Special Director, Directorate of Enforcement, Chennai, under Section 16 (3) of FEMA inter alia, alleging the following contraventions-

• The respondent had remitted Rs. 15,68,88,739 which is in excess of 5% of the local sales, to their parent company QI Limited, Hong Kong, without the approval of Government of India and thereby contravened the provisions of Section 5 of the Act read with Rule 4 rendered themselves liable to be proceeded under Section 13 of the Act.
• The Managing Director of the respondent has also contravened Section 5 of the Act read with Rule 4 has rendered herself liable to be proceeded against for such contravention.

The Adjudicating Authority issued Show Cause Notice to the and its Managing Director, Questnet Enterprises India Private Limited alleging the above contraventions and requiring them to show cause in writing as to why adjudication proceedings as contemplated under Section 16 of the Act should not be held against them.

The respondent filed reply to the show cause notice admitting the remittance of the amount to the tune of Rs. 15,68,88,739.  It was also pointed out that as per Schedule K to Profit and Loss Account of the respondent for the year ending 31/03/2008, the total sales reported was Rs. 428,65,31,544. From this figure sales returns amount totalling to Rs. 13,39,50,045 and commission paid for the sales amount to Rs. 259,88,52,221 were deducted, as part of selling expenses, as per the accounting standards and the income on the account of sales was shown as Rs. 155,37,29,278; that the royalty is payable on local sales and if this is calculated, the royalty of Rs. 15,68,88,739 paid works out to 3.66% of local sales of Rs. 428,65,31,544 which is less than 5%, and hence, no contravention of the Act as alleged in the Show Cause Notice has occurred. 

Personal hearing was afforded to the respondent.  The respondents attended the personal hearing and put forth their arguments before the Adjudicating Authority.  The Adjudicating Authority, after considering the submissions of the respondent, concluded that the allegations against the Noticees are not substantiated and charges were dropped.  Against the order of Adjudicating Authority, the Directorate of Enforcement filed the present appeal before the Appellate Tribunal. 

The appellant contended that the Adjudicating Authority wrongly dropped the charges against the respondents without appreciating the legal and factual position.  The charges were dropped solely on the basis of audit report which was prepared after the investigation started by the appellant.  Further the Auditor has not certified the correctness of the financials as disclosed in audit report and has actually raised a doubt, whether the company had kept requisite books of accounts which is relevant, but this fact has been ignored by the Adjudicating Authority. 

The respondent contended that the auditors have not raised any concern regarding the payment of royalty of the sales figures and thus the said uncertainty raised by the Auditors has no connection to the subject matter of the appeal.  The only issue pertains to the fact whether the royalty paid was within the permissible limits of 5% or not.  The complaint filed by ED itself was based on audited financial statement and the adjudication was also made with reference to the said financial statement. The contention of the appellant that the financial statement and the Auditor’s Report should not have been taken as evidence, because the statements were filed during the period of Investigation would only lead to the absurd conclusion that the entire proceedings starting from the complaint, till the conclusion of adjudication proceedings should be declared as non-est.

The Appellate Tribunal was satisfied with the explanation given by the respondent since no document was filed by the appellant with this appeal to contradict the said financial statement.  The Appellate Tribunal held that the said financial statements cannot be discarded, simply because the same were filed after initiation of proceedings by the appellant.  The appellant failed to appreciate the profit and loss account and statement of expenses incurred in the financial year 2007-08 and the same is not a statement of merely receipt and payments.  It will be incorrect to accept that the royalty of Rs. 15,68,88,739/- paid should be found in the profit and loss account. Hence, the contention raised by appellant is devoid of any merits, as no efforts were made to verify and cross-check the financial statements from the account books of the respondent company, which was seized by the enforcement agencies.

The Appellate Tribunal dismissed the appeal filed by the Enforcement Directorate.