The banking industry has negated the budgetary proposal of finance minister P Chidambaram to slash interest tax on borrowal accounts from 3 to 2 per cents, by using the rounding off methodology.
The banks have been charging interest tax at 2 per cent, as desired by the finance minister. But through an informal arrangement among themselves, they have been rounding off the tax rate to the next highest 0.50 or 0.25 level. With this, the benefit of reduction in interest tax gets totally negated at 13-16 per cent lending rate. The only benefit this methodology accords is to those who borrow at the high interest rate of 25 per cent.
Almost all banks are following this methodology of rounding off the tax to the next highest level of 0.50 or 0.25, since there is no guideline on the computation by either the Reserve Bank or the Indian Banking Association (IBA), said a senior banker working with the credit department of a nationalised bank.
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So far no borrower has complained, though the practice of rounding off the tax on lending rate is not prudent. If borrowers insist, banks may have to compute interest tax on the entire interest income from an account, said the banker.
IBA has told its member banks to persist with the methodology until RBI issues a clarificatory note on the issue, said a banker with a private bank.
According to an official attached to the local chapter of IBA, the apex body of the banking industry has already moved RBI on the issue.
Rounding off the incidence of tax on the lending rate can be reversed if RBI directs banks to have a new mode of computation, he said.
Chidambaram had said in his budget speech: Taxing financial intermediation goes contrary to the canons of sound public finance. I hope to eliminate this levy progressively.
However, the banking industrys attitude, says a borrower, has not changed in tune with the finance ministers perception and, even if the interest tax gets slashed to just 1 per cent, banks may not pass on the benefit to the borrower.