In a move that could impact banks’ profitability from forex trade, the Revenue Department has asked them to pay 0.25 per cent service tax on every forex transaction.
Crucially, the tax will be levied on the rupee equivalent amount for every forex transaction. This is perhaps the main reason that banks are upset with this move. “The presumptive rate of 0.25 per cent on the turnover is unrealistic considering the market realities. Banks do not make this much profit from forex transactions,” said an Indian Banks’ Association (IBA) official.
At the moment, the service tax incidence is 12.36 per cent, or 0.25 per cent of the turnover, if service tax is not levied. After service tax was imposed on forex transactions from May 16 this year, all banks started collecting a uniform fee of Rs 100 per transaction irrespective of the value of the transaction ($100 or $100 million) as well as service tax at the applicable rate.
Banks did not charge a separate fee prior to this and say they have levied a flat service charge to minimise the negative impact on their business. The Revenue Department objects to this practice on the grounds that banks are not capturing the entire margin in forex transactions.
Banks say the levy of 0.25 per cent on every transaction will affect the forex market and result in losses as they will not be able to pass on the additional cost to customers like exporters, who keep converting forex receipts into rupees.
The IBA has already taken up the issue with Finance Minister P Chidambaram, who is understood to have instructed the Department of Financial Services to discuss the matter with the Revenue Department.
Banks make a profit in forex transactions by charging a spread over the foreign currency. If the rupee is traded at 49.50 against the dollar, banks sell dollars above 49.50 but buy at below 49.50.
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Banks attempt to retain a margin while changing currency to cover the forex exposure risk due to daily price movements. Bankers say there is no service component in such transactions. Also, there are hundreds of transactions daily and it is difficult to keep track of gains or losses in each transaction, say banks.
There are broadly two type of forex transactions covered under the tax net — bank-to-bank and bank-to-customers. The margins in inter-bank tradings are very thin. Service tax is not levied on forex transactions between the Reserve Bank of India and banks.