Ex-post-facto approval of foreign share transfer regularises prior approval failure, but source-of-funds breach upholds penalty.

Ex-post-facto approval of a prior foreign share transfer transaction regularised the failure to obtain prior clearance, thereby invalidating penalties imposed on two appellants for that contravention. Separately, lack of satisfactory explanation for the source of funds used to acquire shares remained a distinct compliance breach; the ex-post-facto approval did not waive the obligation to establish lawful funding, and the penalty for that breach on one appellant is sustained. A previously ordered pre-deposit is to be adjusted against the sustained penalty. The appeal is partly allowed accordingly.

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Issues: (i) Whether penalties imposed for contravention of the FEMA regulations relating to transfer/issue of shares can be sustained where the transaction subsequently received ex-post-facto approval from the competent authority; (ii) Whether penalty under Section 3(c) of the FEMA can be sustained against the shareholder who failed to explain the source of funds for acquisition of a portion of shares.

Issue (i): Whether penalties for contravention of Regulation 10(A)(b) / Clause 3 to Schedule 4 read with Regulation 5(3)(2) and Regulation 4 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 can be sustained in view of subsequent ex-post-facto approval by the competent authority (FIPB/Ministry).

Analysis: The transaction involving issuance/transfer of shares was presented to RBI and then to the competent authority; ex-post-facto approval for the transfer/issue to the non-resident was granted and is on record. The competent authority's subsequent regularisation by way of ex-post-facto approval dispensed with the requirement of prior approval in respect of the same transaction and was relied upon in determining whether the regulatory contravention subsists.

Conclusion: The penalties imposed for the alleged contraventions of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 cannot be sustained in respect of the transfer/issue of shares that have been regularised by ex-post-facto approval; appeal in this respect is allowed.

Issue (ii): Whether the penalty under Section 3(c) of the Foreign Exchange Management Act, 1999 can be sustained against the shareholder who failed to explain the source of funds for acquisition of 44,350 shares.

Analysis: The ex-post-facto approval does not relieve parties of other statutory or regulatory requirements under FEMA. The shareholder failed to satisfactorily explain the source of funds for the specified 44,350 shares; this lack of explanation was treated as establishing contravention under Section 3(c).

Conclusion: The penalty imposed under Section 3(c) of the Foreign Exchange Management Act, 1999 in respect of the unexplained source of funds for 44,350 shares is sustainable; the appeal in this respect is partly allowed only to adjust pre-deposit against the penalty.

Final Conclusion: The appeal of the first appellant is partly allowed and the appeal of the second appellant is allowed; penalties relating to the transfer/issue of shares regularised by ex-post-facto approval are set aside, while the penalty for unexplained source of funds is maintained and subject to adjustment of the pre-deposit.

Ratio Decidendi: Ex-post-facto approval by the competent authority, when recorded for the same transaction, regularises the failure to obtain prior approval and precludes sustaining penalties for that regulatory non-compliance, but does not absolve parties from other statutory obligations such as explaining the source of funds under Section 3(c) of FEMA.

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