Why FEMA Compliance in India Should Not be Taken Lightly?

In recent years, India’s Directorate of Enforcement (“ED”) has significantly heightened its scrutiny of transactions under the Foreign Exchange Management Act, 1999 (“FEMA”). What was once a regime focused largely on capital flow irregularities has evolved into a sophisticated enforcement framework examining the substance of foreign direct investment (“FDI”) transactions and underlying business operations.

This shift has profound implications for multinational groups, digital platform operators, and any entity receiving foreign investment into India.

Increasing ED Scrutiny and Investigative Trends

The ED’s enforcement priorities have expanded beyond traditional contraventions involving delays or inaccuracies in FDI filings. Investigations increasingly target business models—particularly in fintech, e-commerce, and hybrid or platform-based sectors—where sectoral classification is not always clear-cut.

Recent patterns show:

• Expanded FDI scrutiny: The ED now examines whether actual business operations align with the stated sectoral classification under which FDI has been received.
• Focus on operational realities: Transactions, fund flows, risk-bearing arrangements, and contractual structures are analysed to determine whether businesses are operating within the approved sectoral conditions.
• Monitoring of evolving digital models: Entities offering marketplace, settlement, or financial-adjacent functions are more frequently examined, especially if their models resemble regulated activities.

How Investigations Are Triggered and Conducted

An ED investigation may be initiated based on:

• Complaints and third-party references
• Inputs from the Reserve Bank of India (“RBI”)
• Media reports
• Red flags in FDI filings and corporate disclosures

Once initiated, the ED typically adopts a comprehensive approach, which includes:

1. Dissection of the Business Model

The ED reviews functional operations, commercial arrangements, and money flows to determine true sectoral alignment.

2. Re-characterisation Where Necessary

If discrepancies arise, the ED may re-interpret the nature of the business based on regulatory guidelines, potentially reclassifying activities into a sector requiring government approval.

3. Enforcement Action

If contraventions are identified, the ED may initiate proceedings under Section 16(3) of FEMA, which can result in adjudication, monetary penalties, and reputational consequences.

The ED’s “Substance Over Form” Approach

A central theme in the ED’s recent actions is the prioritisation of substance over form. The ED increasingly looks beyond corporate descriptions, Memorandum of Association objects, and self-declared classifications.

Under this doctrine, the ED evaluates:

• Actual fund flows and settlement patterns
• Commercial risk allocation
• Core functions performed by the entity
• Related-party interactions
• Impact on end-users or consumers

This broad interpretative latitude enables the ED to scrutinise complex or hybrid models that may blur the lines between technology services and regulated financial or retail activities.
Simply categorising a business as “IT services” or “wholesale trading” will not provide shelter where underlying operations point to otherwise regulated sectors.

Case Study: One Sigma Technologies Private Limited

On July 23, 2025, the ED filed a complaint under Section 16(3) of FEMA against One Sigma Technologies Private Limited and one of its directors for alleged violations amounting to INR 913.76 crore.

Key findings included:

• The company received substantial US-based FDI under the 100% automatic route by declaring itself as providing “information technology and other computer service activities.”
• Operationally, the company functioned as a platform that:
  • collected customer payments on behalf of merchants,
  • managed settlements, and
  • maintained financial records.

The ED concluded that these activities constituted “financial services not regulated by any financial sector regulator”, a sector where FDI requires prior government approval.
Accordingly, the ED proceeded with a formal complaint for violating sectoral conditions.

Other High-Profile Investigations: Flipkart and Myntra

The ED has previously examined the operational structures of major e-commerce platforms such as Flipkart and Myntra.

Myntra Case

• Alleged FEMA violations valued at INR 1,654 crore.
• Myntra claimed to operate as a “wholesale cash & carry” business.
• However, the ED found that Myntra sold goods exclusively to its related party, Vector E-Commerce, which then sold directly to consumers.
• The structure effectively created a B2C retail model, contravening FDI conditions.

Flipkart Case

• A similar structure involving WS Retail led to an alleged FEMA violation of INR 10,600 crore.
• Press reports indicate an ED willingness to close the matter upon compounding and payment of penalties.

These cases illustrate ED’s willingness to look past declared business models and focus on the economic substance of operations.

Risk Mitigation and Best-Practice Compliance Measures

Given the heightened enforcement environment, entities receiving foreign investment should consider the following measures:

1. Robust Sectoral Classification Analysis

Conduct a detailed assessment of operational activities and fund flows before accepting foreign investment.

2. Do Not Rely Solely on the Automatic Route

Where any ambiguity exists, obtaining prior government approval is generally safer.

3. Periodic FEMA Compliance Reviews

Business models evolve over time; regular internal audits help identify potential misalignments early.

4. Careful Use of Hybrid Instruments

Convertible notes, layered corporate structures, and related-party arrangements should be reviewed for FEMA implications.

5. Engage Regulators Proactively

Interaction with the RBI or Department for Promotion of Industry and Internal Trade (DPIIT) may prevent later enforcement action and demonstrate good-faith compliance.

Conclusion

The ED’s enforcement posture under FEMA has become significantly more assertive, particularly in sectors where business models test regulatory boundaries. Organisations receiving FDI—especially in digital or platform-driven industries—must ensure that the substance of their operations aligns with their declared sectoral classification.
A proactive, audit-driven approach to FEMA compliance is no longer optional but essential for mitigating enforcement risk.

By Majmudar & Partners, India, a Transatlantic Law International Affiliated Firm.

For further information or for any assistance please contact india@transatlanticlaw.com

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