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Interpreting the Scope of 'Payment System Operator' Under the PMLA

The Delhi High Court's Landmark Decision in the PayPal Case and Its Implications for Fintech Regulation in India


(Ayan Sharma & Akshit Prajapati)


I. Introduction


In a landmark judgement,[1] the Delhi High Court delivered a crucial verdict on the regulatory status of PayPal, the California-based online payment giant. The court has categorically classified PayPal as a 'Payment System Operator' within the legal framework of the Prevention of Money Laundering Act (PMLA). This judgement alters the compliance landscape for PayPal and carries significant implications for the fintech sector. While affirming PayPal's Reporting Entity (RE) status, the court simultaneously quashed a substantial monetary penalty, deeming it 'unjustified' in light of PayPal's cooperation and bona fide belief regarding its regulatory obligations. In this article, we delve into the legislative background, the intricacies of the judgement, and its impact on PayPal operations and the fintech industry as a whole.


II. Legislative Background


The Prevention of Money Laundering Act ("PMLA"), introduced in 2005, forms the legal foundation for India's fight against money laundering and the prevention of illicit financial activities. The primary objective of the PMLA is to curb crimes associated with money laundering and penalise those involved. The Act's origins trace back to international efforts, including the UN Convention Against Illegal Traffic in Narcotic Drugs and Psychotropic Substances and recommendations by the Financial Action Task Force (FATF). The PMLA underwent amendments over the years to align with international standards, introducing the concept of "compliance" to harmonise Indian law with other countries and broadening the definition of "reporting business" to include various financial entities.


Furthermore, Know Your Customer (KYC) and Customer Due Diligence (CDD) guidelines have also been established across the financial sector, enabling institutions to monitor and assess their clients' financial engagements to prevent the influx of illicit funds.


III. The Judgement


PayPal's Position

PayPal operates as an Online Payment Gateway Service Provider (OPGSP) with a focus on facilitating cross-border transactions. It falls under the regulatory oversight of the Reserve Bank of India, as outlined in their notification. [2] This notification establishes criteria for the processing and settlement of import and export-related payments by OPGSPs. PayPal forms continuous contractual arrangements with banks that are categorised as Authorised Dealer Category-I Schedule Commercial Banks (AD Banks). Notably, PayPal plays a pivotal role in facilitating Indian exporters and sellers in receiving cross-border payments from foreign remitters and buyers. A crucial point of contention arises regarding the nature of the offshore account in which foreign remitters' payments are pooled; while PayPal contends that it belongs to a "Global acquirer/aggregator," the respondent, the Financial Intelligence Unit India (FIU), disputes this representation, suggesting it is an "offshore account" of PayPal. However, the Delhi High Court did not reach a definitive conclusion on this matter.


PayPal initiated the present petition before the Delhi High Court to challenge the order of the FIU, dated December 17, 2020, which categorized PayPal as a Reporting Entity (RE) under the Prevention of Money Laundering Act (PMLA) and imposed a monetary penalty of approximately INR 96,00,000 (US$ 115,419) pursuant to Section 13(2)(d) of the PMLA. The alleged violations include multiple aspects:


Firstly, the individual's contravention of Section 12 of the Prevention of Money Laundering Act (PMLA), involving intentional avoidance of responsibilities related to the maintenance and disclosure of transaction data due to a failure to register as a Reporting Entity (RE) as mandated by the PMLA;


Secondly, non-compliance with Rule 7 of the PMLA Maintenance Rules, including the failure to register and provide essential information regarding the Designated Director to the Financial Intelligence Unit (FIU); and


Thirdly, a violation associated with Rule 7 of the PMLA Maintenance Rules, focusing on the failure to register and disclose the identity and contact details of the primary officer.


PayPal argued against its classification as a Payment System Operator (PSO) according to the Prevention of Money Laundering Act (PMLA), asserting that it should not be considered a reporting entity. PayPal defended its stance by emphasising that its role is limited to serving as a technological intermediary for export transactions rather than actively facilitating the movement of funds between an Indian payee/exporter and an overseas payer/buyer. PayPal said that it does not engage in the process of enrolling overseas remitters/payers in export transactions. Its involvement is limited to onboarding Indian payees/exporters and providing them with a payment connection to facilitate transactions with international entities. The process of enrolling international remitters and facilitating the transfer of funds is executed and overseen by the AD Banks upon the completion of each transaction. Consequently, PayPal asserted that the handling of funds, clearing, payment receipt, and settlement activities are the responsibilities of the AD Banks, not PayPal. To support its stance, PayPal drew attention to the identical definition of 'payment system' under the Payment and Settlement Systems Act (PSS) Act, where payment gateways like OPGSPs are not designated as PSOs. Furthermore, PayPal referenced an affidavit issued by the RBI in another case[3], affirming that OPGSPs, including PayPal, do not qualify as PSOs under the PSS Act.


Findings of the Delhi High Court

Regulatory Treatment of Payment Aggregators

The Delhi High Court discerned that payment aggregators and Online Payment Gateway Service Providers (OPGSPs) are treated differently under the Payment and Settlement Systems (PSS) Act. Notably, OPGSPs, functioning as technology providers, do not appear to be regulated or licenced under the PSS Act, even if they have some involvement in the payment chain. This distinction in treatment under the PSS Act does not automatically translate into the same classification under the Prevention of Money Laundering Act (PMLA). The Delhi High Court emphasised that the objectives and legislative policies governing payment systems' treatment differ between the PMLA and the PSS Act. Under the PMLA, the term "payment system operator" should be interpreted to ensure the effective implementation of its provisions, preventing offenders from evading the law's reach.


PayPal's Role with UPI Third-Party Application Providers

The Delhi High Court established a key distinction between the petit and Unified Payment Interface (UPI) Third-Party Application Providers (TPAPs), like Google Pay or Amazon Pay. It noted that, unlike UPI TPAPs, PayPal actively participates in onboarding foreign parties within the OPGSP framework. Throughout the onboarding procedure, PayPal establishes a nodal/collection account with a financial institution, which serves as the channel for routing OPGSP money. The AD Banks manage the allocation of credits and debits within this account in accordance with PayPal's instructions. In contrast, Third-Party Payment Providers (TPAPs) facilitate complete transactions directly from the bank accounts of the transacting parties, with the relevant information already documented by authorised deposit-taking banks.


Interpreting PSOs

The Delhi High Court observed that the inclusion of the phrase "enabling" in the definition of a "payment system operator" embraces systems that facilitate, enable, or promote payment transactions between individuals making payments and individuals receiving payments. Moreover, the phrase "involving" as stated in the definition of a "payment system" encompasses all aspects and characteristics during the progression of a payment transaction. Hence, these interpretations possess the potential to be applicable to any entity involved in the payment process, irrespective of their direct involvement in fund handling, but rather due to their essential role in the system. The Delhi High Court underscored the primary aim of the Prevention of Money Laundering Act (PMLA) as the prevention of money laundering, hence requiring the examination of all data points created during a transaction. Also, the fact that PayPal works with other PAs (payment aggregators) or ADs (authorised dealers) in the transactions would not change the fact that the platform is known as a space for payments and money transfers. As a result, PayPal was classified as a "payment system operator" under the PMLA based solely on its activities within the scope of the PMLA, without considering its operations in other jurisdictions where it offered more than a technological interface for payments.


The FIU had previously imposed a substantial penalty on PayPal based on alleged violations of Reporting Entity (RE) obligations under the PMLA. The Delhi High Court decided to discharge this penalty on two primary grounds:

  1. That PayPal genuinely believed it was not a PSO and did not willfully contravene a statutory obligation, particularly when the legal position on this matter was unclear, further supported by differing stances taken by the RBI and FIU.

  2. That it co-operated with the FIU throughout, even while contesting its R status, including suggesting alternative mechanisms to share information in a letter to the FIU.

IV. Implications and the Road Ahead


Classification of Domestic Payment Gateways and PSOs

When considering the implications of the Delhi High Court judgement for domestic payment gateways, distinctions emerge that favour these entities regarding their classification as PSOs under the PMLA. Domestic payment gateways, lacking licences as PSOs under the Payment and Settlement Systems (PSS) Act, are less likely to fall under the PSO category, according to the PMLA. This distinction arises from the accessibility of transaction details, which are already available to AD Banks or licenced payment aggregators facilitating online transactions in line with the PSS Act. This differentiation aligns with the PMLA's objectives and intent.


Defining PSOs under the PMLA

The core impact of the Delhi High Court judgement lies in defining what constitutes an entity as a PSO under the PMLA. This decision hinges on a dichotomy between a definition-based and a function-based approach. The former extends PSO classification to any participant in the payment chain that plays a crucial enabling role, potentially affecting various payment intermediaries, including domestic gateways. In contrast, the function-based approach mandates a meticulous analysis of the extent to which an entity has access to transaction details, excluding AD Banks. Such determinations need to be made on a case-by-case basis to prevent overreach while ensuring compliance among payment intermediaries and promoting ongoing technological innovation in this sector.


Implications of the Judgement for PSOs

The recent judgement by the Delhi High Court (DHC) has significant implications for entities operating in roles akin to PayPal, potentially subjecting them to heightened obligations and compliance requirements under the Prevention of Money Laundering Act (PMLA). This verdict centres around two critical criteria for evaluating technology service providers as PSOs under the PMLA. Firstly, these providers need not engage in direct fund handling, thus broadening the scope beyond traditional financial institutions. Secondly, their roles in onboarding transaction parties and accessing transaction details assume a significant role. This precedent-setting decision underscores the need for a nuanced, case-specific assessment, especially for cross-border payment intermediaries.


Conclusion


The Delhi High Court's landmark decision in the PayPal case has far-reaching implications for fintech regulation in India. The court's classification of PayPal as a PSO under the PMLA broadens the regulatory scope for entities in the financial technology sector. This decision requires a nuanced assessment of entities as potential PSOs based on their involvement in onboarding transaction parties and access to transaction details. While it impacts cross-border payment intermediaries, domestic gateways are less likely to be classified as PSOs. The decision underscores the importance of regulatory compliance, the role of data in anti-money laundering efforts, and the need for continuous adaptation in the dynamic fintech regulatory landscape.

 
Endnotes
  1. https://www.livelaw.in/pdf_upload/judgementphp-3-482750.pdf

  2. Reserve Bank of India - Notifications. (n.d.). https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10037

  3. S. (2023, August 28). "Google Pay is a mere third-party app provider, no authorization required from RBI"; Delhi HC | SCC Blog. SCC Blog. https://www.scconline.com/blog/post/2023/08/21/delhi-hc-dismisses-pil-to-cease-google-pays-operations-legal-news/


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