2026 (3) TMI 204 - AT - FEMA

Round-tripping: Offshore SPVs lacking bona fide activity used to raise funds and reinvest in India are treated as circumvention of FEMA norms.

Whether funds raised abroad through wholly owned overseas subsidiaries and returned as investment into Indian group companies amounted to impermissible ... Round-tripping - Establishment and use of two wholly owned overseas subsidiaries and their borrowings, followed by reinvestment into Indian group companies - bona fide business activity - contravention of Section 6(3)(a) of the Foreign Exchange Management Act, 1999 - application of Regulations 6(2)(ii) and 7 of the FEMA (Transfer or Issue of Any Foreign Security) Regulations, 2004 - reliance on Reserve Bank of India observations and independent application of mind by the adjudicating authority. Round-tripping - bona fide business activity - Whether investments made through two wholly owned overseas subsidiaries amounted to round tripping and thereby contravened Section 6(3)(a) of FEMA, 1999 and Regulations 6(2)(ii) and 7 of the 2004 Regulations. - HELD THAT: - The Tribunal examined the formation of two wholly owned subsidiaries in Mauritius, their minimal initial equity, subsequent large borrowings from overseas banks and reinvestment into group companies in India. Relying on the Supreme Court's discussion of 'round tripping' and the IMF definition, the Tribunal accepted that channeling of local funds abroad and their return as direct investment can constitute round tripping. The Tribunal found the subsidiaries were not carrying on bona fide overseas business operations but were used to obtain foreign borrowings which were reinvested into related Indian group entities. Having regard to the statutory scheme permitting outward direct investment only where the overseas JV/WOS is engaged in bona fide activity and the safeguards in Regulation 7 for entities engaged in financial services, the Tribunal held the transactions circumvented the relevant regulatory framework and amounted to contravention of Section 6(3)(a) read with Regulations 6(2)(ii) and 7. The Tribunal rejected the appellants' submissions that inward FDI/investment via authorised dealers or absence of a statutory definition of 'round tripping' absolved them, treating the overall facts as establishing impermissible round tripping and regulatory breach. [Paras 21, 22, 23, 24, 25] The Tribunal upheld the finding that the overseas investments constituted round tripping and were not bona fide business activity, and that the transactions contravened Section 6(3)(a) of FEMA, 1999 and Regulations 6(2)(ii) and 7 of the 2004 Regulations. Reliance on Reserve Bank of India observations and independent application of mind by the adjudicating authority - Whether the Special Director acted mechanically by merely reproducing RBI observations without independent analysis so as to vitiate the penalty order. - HELD THAT: - Appellants contended the order was a mechanical adoption of RBI's letter without application of mind. The Tribunal reviewed the impugned order and the material considered by the Special Director, including the replies of the appellants and the RBI communication. The Tribunal concluded that the Special Director did more than reproduce RBI observations: he analysed the factual matrix, referred to the nature and use of the overseas subsidiaries, and applied relevant legal concepts (including the concept of round tripping) in reaching the conclusion. Consequently, the Tribunal found no procedural infirmity of blind adoption of RBI's view that would require interference. [Paras 23, 24] The Tribunal rejected the submission of mechanical reliance on RBI and held that the Special Director applied his own analysis and mind in recording the finding and imposing penalty. Final Conclusion: The appeals were dismissed. The Tribunal upheld the Special Director's conclusion that the two overseas wholly owned subsidiaries were used for round tripping and not bona fide business activity, and that the transactions contravened Section 6(3)(a) of FEMA, 1999 and Regulations 6(2)(ii) and 7 of the 2004 Regulations; it also held that the adjudicating authority had applied independent mind in arriving at the penalty. Issues: Whether the establishment and use of two wholly owned overseas subsidiaries and their borrowings, followed by reinvestment into Indian group companies, amounted to 'round tripping' and thereby contravened Section 6(3)(a) of the Foreign Exchange Management Act, 1999 read with Regulation 6(2)(ii) and Regulation 7 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004.Analysis: The Tribunal examined Section 6(3)(a) (empowering RBI to regulate transfer or issue of any foreign security) and Regulation 6(2)(ii) (permitting direct investment abroad only where the overseas JV/WOS is engaged in bona fide business activity) alongside Regulation 7 (additional conditions where the Indian party is in the financial services sector). The factual matrix showed two wholly owned subsidiaries incorporated with nominal capital, which obtained substantial loans from overseas branches of ICICI Bank and invested those funds into Indian group companies (including purchases of redeemable preference shares). The Tribunal considered RBI's observations and relevant jurisprudence (including the Supreme Court's discussion of 'round-tripping'), and accepted the view that channeling local funds abroad via SPVs and returning them as direct investment falls within the accepted concept of 'round tripping' where the overseas entities lack bona fide business operations and serve primarily to raise overseas funds for reinvestment in India. The Tribunal found that the Special Director had applied the statutory provisions to the record, relied on RBI's findings and supporting material, and concluded that the overseas subsidiaries were not engaged in bona fide business activity and that the transactions circumvented applicable regulatory norms.Conclusion: The Tribunal upheld the finding of contravention of Section 6(3)(a) of the Foreign Exchange Management Act, 1999 and Regulations 6(2)(ii) and 7 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004, and dismissed the appeals.