Capital and Current Account Transactions Under FEMA: A Complete Guide

Your startup just raised $2M from a Silicon Valley VC. Great news! But now the bank's asking for forms you've never heard of. Meanwhile, your freelance friend received $ 5,000 from the same region with just an invoice. 

Why the difference? FEMA classification.

Misclassify a transaction, and a 2-day payment can turn into a 2-month delay and attract penalties. FEMA doesn't care about your growth plans; it cares whether you're creating assets abroad (capital account) or earning income (current account).

Most Indian startups are flying blind on FEMA rules. This guide helps you classify payments correctly, avoid red tape, and focus on growing globally.

• Capital account transactions involve creating or altering assets or liabilities abroad. This includes investments, real estate purchases, or foreign loans.

• Current account transactions cover routine business payments such as exports, service income, travel expenses, and software imports. These are more liberalized and rarely need RBI approval.

• Correct classification is a must. Misclassifying a transaction can lead to delays, compliance penalties, or even regulatory action.

• Common documentation includes Form FC-GPR for capital inflows, e-FIRAs for export proceeds, share valuation reports, purpose codes, and Form 15CA/CB for outward remittances.

• Use platforms like Xflow to simplify compliance: automatic classification, real-time e-FIRA generation, accurate purpose code mapping, and hands-free reporting.

• Recent trends show increased scrutiny on capital account routes, especially under LRS and for startup funding, making it vital to stay updated with RBI circulars.

Under the Foreign Exchange Management Act (FEMA), capital account transactions are defined as those that alter the assets and liabilities, including contingent liabilities, of a person resident in India with respect to their assets and liabilities outside India, or of a person resident outside India with respect to their assets and liabilities in India. Essentially, these transactions involve the movement of capital across borders, impacting ownership of assets and liabilities between residents and non-residents.

Common capital account transactions:

• Inbound investments (FDI): Foreign investors buying equity in Indian startups or companies.
• Outbound investments (ODI): Indian companies acquiring shares, property, or assets abroad.
• External commercial borrowings (ECBs): Indian entities raising loans from foreign lenders.
• Import of capital goods on deferred payment terms: Large equipment or machinery purchases financed over time.

These days, many capital transactions don’t need prior approval from the RBI. They fall under what’s known as the automatic route, where Authorized Dealer (AD) banks can handle the process on their own. This has made things much easier for businesses.

Take a tech startup, for example. If it’s raising Series A funding from a U.S. venture capital firm, it can usually move ahead without extra paperwork. The funding comes in, the AD bank verifies the details, and the deal gets reported to the RBI.

But not everything qualifies for this ease. If an Indian company plans to buy a business abroad, the rules can get stricter. Depending on the sector or the size of the deal, RBI approval might still be needed.

In all these cases, AD banks play a central role. They check if the transaction meets regulations, collect documents, and keep the RBI in the loop. Without them, the flow of cross-border capital would be far more complicated.

Compliance and documentation

• Form FC-GPR – for issuing shares to foreign investors
• FLA return – annual report of foreign liabilities and assets
• Share valuation reports – for equity-based capital inflows
• Board resolutions and investment agreements – as supporting proof

Recent RBI updates have particularly focused on startup investments, with clearer guidelines on convertible instruments and downstream investments. The central bank has also been refining the automatic route limits and sector-specific conditions.

Current account transactions, as defined under Section 5 of FEMA, refer to day-to-day operational flows that do not alter an individual's or a company's asset-liability position. These include payments for exports, services, travel, and routine imports, and are typically more liberalized than capital account transactions.

Common current account transactions:

• Export of goods and services
• Payments received for IT services, design work, consultancy, and merchandise exports
• Professional and salary income from abroad
• Freelancers and remote workers receiving foreign income
• Dividend and interest payments
• Income earned from investments abroad (non-repatriable under current account rules)
• Business travel and operational expenses
• Remittances for overseas travel, training, software subscriptions, and more
• Routine imports
• Payments for importing consumables, raw materials, or software tools

Compliance and documentation

• e-FIRAs or FIRCs
• Mandatory for export earnings or inward remittances under the current account
• Purpose codes
• Correct classification of transaction nature (e.g., P1017 for IT services)
• Import Export Code (IEC)
• Required for most business-related international transactions
• Invoices and contracts
• Documentation to support the nature and value of the service or product

The regime here is largely liberalized. You don't need RBI approval to receive export proceeds or make most business payments abroad.

Recent updates have focused on streamlining outward remittance reporting and rationalizing purpose codes to reduce confusion. The RBI has also been pushing for more digital reporting through the EDPMS (Export Data Processing and Monitoring System) and similar platforms.

Let's take the case of Ankit, an Indian entrepreneur running a successful SaaS company. Ankit wants to expand his operations by opening a small sales office in the UK and also plans to send monthly payments to support his sister, who is studying in Canada.

The monthly payments to his sister for her living expenses and tuition fall under current account transactions. These are permitted under the Liberalised Remittance Scheme (LRS) and can be made without special RBI approval, as long as they stay within the annual limit and are supported by basic documentation.

However, if Ankit decides to invest in commercial property in the UK to house his sales team or becomes a shareholder in a UK-based company, that would qualify as a capital account transaction. These activities involve creating assets abroad, which affect India's foreign exchange position and fall under stricter FEMA and Overseas Direct Investment (ODI) regulations. They require additional filings and approvals.

Key distinction:

• Current account = recurring operational expenses (e.g., support, services, travel)
• Capital account = long-term asset creation or ownership abroad

Understanding this line helps entrepreneurs like Ankit avoid compliance pitfalls and structure their cross-border payments correctly.

Here's a simple checklist. 

Step 1: Ask the core question

Is the transaction creating or altering an asset or liability abroad?

• Yes → Likely a capital account transaction

• No → Likely a current account transaction

Step 2: Check the intent and nature

Current account includes:

• Export payments (goods or services)

• Freelance income

• SaaS subscription revenue

• Business travel or operational expenses

• Import of raw materials/tools

Capital account includes:

• Foreign investments (equity or real estate)

• External commercial borrowings (ECBs)

• Startup funding (VC rounds)

• Acquisition of overseas businesses or assets

• Setting up a branch or office abroad

Real examples

• Freelance designer receiving monthly fees → Current

• Same designer buying US company shares → Capital

• Indian startup earning SaaS revenue → Current

• Startup raising Series A from US VC → Capital

Common mistakes to avoid

• Assuming all foreign service payments are current account. Check if it's tied to equity or asset creation.
• Not filing Form FC-GPR for capital inflows like FDI, even under the automatic route.
• Using incorrect purpose codes can lead to compliance flags and bank delays.
• Skipping e-FIRA collection for exports, causing issues during GST refunds or audits.
• Ignoring Form 15CA/15CB requirements for outward payments above threshold limits.

Latest developments and policy trends

• The RBI has been actively modernizing FEMA compliance through its fintech sandbox initiatives and digital reporting systems. Recent updates include API-based reporting systems, real-time transaction monitoring, and streamlined documentation processes.
• There's been a noticeable tightening of the Liberalized Remittance Scheme limits and increased scrutiny of capital account routes, particularly for startups and fintech companies. The digitization of FIRA issuance has made export compliance faster and more transparent.
• The push for greater transparency in capital inflows, especially through startup funding rounds, reflects the RBI's focus on monitoring hot money flows and ensuring genuine investments.

FEMA compliance doesn't have to be a maze of forms, codes, and bank delays. Platforms like Xflow automate the entire process—classifying transactions under the correct FEMA route, applying the correct purpose codes, and instantly generating e-FIRAs for current account flows, such as service exports.

For Indian exporters and startups, Xflow ensures:

• Automated compliance for GST, IEC, and FEMA filings.
• Instant e-FIRA issuance for faster, audit-ready documentation.
• Accurate purpose code mapping without guesswork.
• INR settlements with better FX rates.
• Hands-free reporting, even without a compliance team.

Understanding the difference between current and capital account transactions is key, but with the right platform, you don't have to manage it alone. Xflow reduces errors, speeds up payments, and turns compliance into a competitive edge.