P0016 Purpose Code (with Examples)

According to the RBI, it is for transactions related to “Purchase of a foreign currency against another currency.”

This code is used for transactions where one foreign currency is bought by selling another foreign currency, without involving the Indian Rupee. This typically occurs in the foreign exchange (forex) market, often by Authorised Dealer (AD) banks or entities engaged in international trade or investment.

For Example, a person may sell US Dollars to purchase Euros or Japanese Yen, depending on their overseas requirements. These transactions are reported under purpose code P0016 and are common for hedging, trade settlements, or managing foreign currency exposures.

Who Can Purchase/Exchange the Foreign Currency under P0016

Foreign currency is typically purchased against another foreign currency by the following entities –

• Authorised Dealer (AD) Banks – Authorised Dealer (AD) banks are the main participants and facilitators in the foreign exchange market. They frequently buy and sell foreign currencies in the interbank forex market for various purposes, such as trading, arbitrage, or to execute transactions on behalf of their clients.

• Businesses and Corporates – Corporates and exporters/importers engaged in international trade often need to convert one foreign currency into another to manage their global transactions. For example, a business earning in USD may need to convert those dollars into euros (EUR) to pay a supplier based in Europe. This type of currency exchange helps companies settle cross-border invoices, manage foreign liabilities, and reduce currency risk, and is typically carried out through authorised dealers or banks under proper regulatory reporting.

• Foreign Portfolio Investors (FPIs) and Financial Institutions – They often need to shift funds between different currencies to manage and rebalance their investment portfolios. For example, they may move funds from USD assets to Euro-denominated securities based on market conditions, interest rate changes, or investment strategies. This kind of currency conversion is a routine part of international investment operations, allowing them to optimise returns and manage currency exposure across various global markets.

• Currency Traders and Forex Dealers – These are individuals or entities that engage in speculative or arbitrage-based trading of foreign currencies. They actively buy and sell multiple foreign currencies to profit from exchange rate fluctuations. These traders operate in global currency markets, often dealing directly in large volumes, and may include banks, financial institutions, or professional traders. Their activities are typically fast-paced and driven by market trends, economic indicators, and geopolitical events.

Purpose of Requiring Foreign Exchange

• Third-Currency Trade Settlements – Third-currency trade settlements happen when a buyer and a seller from two different countries do business, but instead of using either country’s currency, they use the currency of a third country to complete the payment.

• Foreign Investments – This can include purchasing foreign securities such as shares or bonds, acquiring property or other assets abroad, or participating in joint ventures with foreign businesses.

• Hedging and Risk Management – This can include purchasing foreign securities such as shares or bonds, acquiring property or other assets abroad, or participating in joint ventures with foreign businesses.

• Travel and Education Payments Abroad – When a student or traveler already holds one foreign currency, such as US dollars (USD), and needs to convert it into another currency like Canadian dollars (CAD) or British pounds (GBP) for expenses in a different destination, they can do so through a currency conversion transaction. This often happens when individuals carry leftover foreign currency from previous trips or education-related payments and need to adapt to the currency requirements of a new country.

• Repatriation of Overseas Earnings – Foreign subsidiaries of Indian companies can repatriate their overseas earnings by converting retained profits or income into a desired foreign currency. These converted funds can then be remitted back to the Indian parent company or used for reinvestment abroad, depending on the business strategy and regulatory permissions.

• Multinational Company (MNC) Treasury Operations – MNCs often have internal treasury operations that manage funds across their global subsidiaries. As part of this, treasury units may rebalance currency holdings between countries to manage foreign exchange exposure, optimise liquidity, or meet local funding needs. This can involve moving funds between group entities in different currencies, depending on market conditions, business requirements, or regulatory considerations.

• Interbank Foreign Exchange Transactions – Authorised Dealer (AD) banks often carry out interbank foreign exchange transactions by engaging in currency swaps or spot and forward purchases of one foreign currency against another. These transactions are typically part of their regular market-making activities or arbitrage strategies, allowing them to manage liquidity, hedge exposures, or take advantage of price differences between markets. Such trades are common in the interbank forex market and are essential for maintaining efficient currency flows and pricing.

• Payment of Offshore Loans or Liabilities – When an Indian borrower holds foreign currency, such as in an EEFC, RFC, or foreign currency account, and needs to repay an offshore loan or liability in another currency, they can use those funds directly for servicing the debt. This typically applies in cases where the borrower has earnings in foreign exchange and is required to make payments towards external commercial borrowings (ECBs) or other permitted offshore obligations. In such scenarios, conversion between currencies may be required.

Important Rules for Currency Exchange under P0016

The rules for purchasing foreign currency against another foreign currency under Purpose Code P0016 (as per RBI and FEMA regulations) are as follows:

• No Involvement of INR – Under purpose code P0016, the transaction must strictly involve the purchase of one foreign currency against another, such as USD to EUR or GBP to JPY. There should be no involvement of Indian Rupees (INR) in the transaction. These are cross-currency dealings where both currencies are foreign, and INR is completely excluded from the exchange process.

• Allowed Entities – Only Authorised Dealer (AD) Category-I banks and entities or individuals who are specifically permitted under the Foreign Exchange Management Act (FEMA) are allowed to carry out transactions under this category. These entities are authorised by the Reserve Bank of India to deal in foreign exchange and ensure that all such transactions comply with the applicable rules and regulations.

• Permitted Purposes – Permitted purposes for such transactions include trade settlements involving third currencies, making investments abroad, payments related to foreign travel or education in non-INR currencies, and managing currency exposure through hedging or forex risk management strategies. These transactions are also allowed for interbank forex trading, where banks deal in foreign exchange with each other as part of market operations.

• Routing through AD Banks – Routing through an AD Bank is an important aspect for foreign currency exchange, as these banks are responsible for reporting the transaction under purpose code P0016 through the Foreign Exchange Transaction Electronic Reporting System (FETERS), which is the RBI’s system for tracking foreign exchange transactions.

• Anti-Money Laundering Compliance – Banks are required to verify the identity and legitimacy of both the sender and receiver before processing cross-border loan transactions. If any transaction appears suspicious or lacks proper documentation, it may be flagged and reported to the Financial Intelligence Unit-India (FIU-IND) for further investigation. This ensures that the funds being transferred are not linked to illegal activities and helps maintain transparency in foreign financial dealings.

• LRS (Liberalised Remittance Scheme) – LRS is not applicable under purpose code P0016 because the transaction involves the purchase of foreign currency using another foreign currency, not a remittance from an Indian Rupee (INR) account.

Types of Accounts Used for P0016 Transactions

• Exchange Earners’ Foreign Currency (EEFC) Account – It is a type of account held by Indian residents, typically exporters or service providers, to retain their foreign exchange earnings without converting them into Indian Rupees (INR). These accounts allow holding balances in foreign currencies like USD or EUR, providing flexibility and helping reduce currency conversion costs.

• Resident Foreign Currency (RFC) Account – This account is meant for returning NRIs or resident individuals who have foreign income. It allows them to hold funds in freely convertible foreign currencies such as USD, EUR, or GBP. One of the key benefits of an RFC account is that the funds can be retained in foreign currency without converting them to INR. These funds can be converted into another foreign currency (for example, from USD to GBP) and used for purposes like investment, travel, or education abroad.

• Foreign Currency Non-Resident (FCNR) Account [for NRIs] – It is a type of fixed deposit account held in foreign currency by Non-Resident Indians (NRIs). It allows NRIs to earn tax-free interest in India while avoiding exchange rate risk. One key benefit of the FCNR account is that NRIs can use the funds to convert into another foreign currency, if needed, for specific purposes abroad, such as investments, education, or travel, making it a flexible and convenient option for managing overseas financial needs.

• Foreign Currency Account of Indian Companies or Branches – Indian companies or their overseas branches that have international operations are allowed to maintain foreign currency accounts either abroad or in India. These accounts are typically used for purposes such as treasury management, third-country trade, or making overseas investments. When cross-currency transactions take place between such foreign currency accounts, whether held in India or abroad, they are reported to the RBI.

• Nostro Accounts (Bank-to-Bank Transactions) – Nostro accounts are used by Authorised Dealer (AD) banks to carry out bank-to-bank foreign exchange transactions, especially for settling trades in foreign currencies. When two banks convert one foreign currency into another, such as USD to EUR, without involving Indian Rupees (INR), these are interbank conversions.

How to Report the Purpose of The Transaction to The RBI by Giving the Purpose Code:

Investors involved in foreign currency exchange in India must file several forms before starting the process. Usually, the transactions are via bank transfers, and your bank will ask you to provide a purpose code by giving a form to fill out. If you have any doubts or questions, feel free to reach out to us via email- support@bankerpanda.com, and we will try our best to help you out.

Tax or No Tax?

In general, no direct tax like GST or income tax is charged on a P0016 transaction itself, as it simply involves converting one foreign currency into another without involving Indian Rupees (INR). However, if this currency exchange is part of a broader financial activity, like investing abroad, importing services, or receiving income from foreign sources, then tax implications may arise based on that activity. In such cases, a rebate or exemption may be applicable. Below are some of the use-cases:-

• Interest on NRE Accounts for NRIs (not relevant to P0016 but often confused).

• Dividend income from certain foreign subsidiaries is exempt under specific provisions (though most are now taxable).

• Gifts received in foreign currency from relatives or on specific occasions (not taxable under Section 56).

• Paying for overseas education or travel.

• Making advance payments for services or goods.

• Treasury operations of a company without profit impact.

• Holding in a foreign currency account without earning interest.

• Returning NRIs who hold RFC accounts, certain income (like interest on deposits in foreign currency) is exempt for a specific period under Section 10(15)(iv)(fa).

P0016 Purpose Code Use Case Examples:

Here are some real-life examples where the RBI’s Purpose Code P0016 would be used to report transactions in India-

• Exporter Paying a Supplier in a Third Country:-
  An Indian IT company develops a custom AI-based analytics software and holds the copyright. A U.S. healthcare firm wants exclusive rights to use this software in North America and agrees to buy the copyright for $1 million. The Indian company transfers ownership and receives the payment in foreign currency. The transaction is reported under P0017 since it involves the sale of an intangible asset (copyright) to a foreign buyer.

• Business Hedging Currency Risk:-
  A large Indian manufacturing firm expects to receive payment in British Pounds (GBP) for an export order after three months. To hedge against future currency fluctuations, the company decides to buy GBP today using its existing US Dollar (USD) reserves. This forward-looking exchange of USD to GBP is executed through its AD bank purely for hedging purposes. As the transaction is a conversion between two foreign currencies and does not involve INR, it falls under P0016.

• Treasury Operations of a Multinational Company:-
  An Indian branch of a multinational corporation maintains funds in Japanese Yen (JPY) and is instructed by its European headquarters to transfer funds in Euros (EUR). To fulfil this, the Indian office converts JPY to EUR through its authorised bank. This internal treasury movement, aimed at optimising global fund allocation across regions, is a cross-currency transaction. Since no INR is involved, this operation is recorded under Purpose Code P0016.

• Individual Using RFC Account for Foreign Investment:-
  A returning NRI has opened a Resident Foreign Currency (RFC) account in India, holding savings in USD earned during their overseas employment. They decide to invest in Canadian mutual funds, which require payment in Canadian Dollars (CAD). The individual approaches their AD bank to convert USD from the RFC account to CAD for this purpose. Since the conversion is between two foreign currencies and the investment is abroad, the transaction is classified under P0016.

• Interbank Currency Swap:-
  An Authorised Dealer (AD) bank in India engages in a currency swap with a foreign bank where it agrees to sell Japanese Yen (JPY) and buy Euros (EUR) as part of its regular interbank trading or liquidity operations. This type of foreign exchange transaction between banks, involving no INR and aimed at managing forex positions or earning trading income, is a textbook example of a P0016 transaction.

• Student Converting One Foreign Currency to Another:-
  An Indian student studying in Japan receives funds from their family in US Dollars (USD) via wire transfer. However, to pay tuition and cover daily expenses locally, the student needs Japanese Yen (JPY). Instead of converting the funds into INR first, the student directly converts USD to JPY at an AD bank. As this is a foreign currency conversion for educational purposes abroad, and does not involve INR, it is reported under P0016.

• NGO Making International Donation in Local Currency:-
  An Indian NGO receives foreign aid in USD to support global humanitarian work. It decides to donate part of this aid to a relief organisation in Kenya, which requires the funds in Kenyan Shillings (KES). To process the payment, the NGO converts USD into KES through its AD bank. Since the conversion involves two foreign currencies and does not touch INR, the transaction is reported under P0016.

• Indian Airlines Paying Fuel Supplier in Foreign Currency:-
  An Indian airline operating international routes needs to pay for fuel in Russian Rubles (RUB) at a foreign airport. It uses revenue held in Euros (EUR) collected from European passengers. The airline converts EUR to RUB for this specific transaction. Since INR is not involved and the transaction is between two foreign currencies, it is classified under P0016.

• Indian Company Repaying Offshore Loan in Different Currency:-
  An Indian company has raised an external commercial borrowing (ECB) in USD but needs to repay part of the loan to a new lender in Singapore Dollars (SGD) due to refinancing. It uses USD funds from its overseas account to purchase SGD for repayment. As this transaction is between two foreign currencies and structured through the banking system, it is reported under P0016.

• Investment Fund Diversifying Foreign Holdings:-
  An Indian investment fund holds surplus liquidity in Swiss Francs (CHF) and wants to diversify by investing in Australian Government Bonds, which require Australian Dollars (AUD). The fund instructs its custodian bank to convert CHF to AUD through a forex deal. This foreign-to-foreign currency investment allocation is reported under Purpose Code P0016.

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