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Banks may get service tax breather on forex turnover
February, 16th 2009

The finance ministry may give relief to banks by lowering service tax on their foreign exchange turnover.

At present, the banks and the Central Board of Excise and Customs (CBEC), which administers indirect taxes, are locked in a tussle with the latter asking the banks to collect service tax at the rate of 0.25 per cent on every forex transaction.

Banks have resisted the CBEC move by saying that there is no service component in forex transactions and that the tax may make forex business unviable as it operates on very thin margins.

The Indian Banks Association (IBA), the apex forum of commercial banks, has already taken up the issue with the finance ministry, which has acknowledged its concerns and has instructed the revenue department to address the issue. Both government and banking sources say that the service tax rate is likely to be lowered.

The presumptive rate of 0.25 per cent on the turnover is unrealistic as banks may not be making profit at all, said a senior banker.

Crucially, banks are upset that the tax has to be levied on the rupee equivalent amount for every forex transaction. At present, the service tax incidence is 12.36 per cent, or 0.25 per cent of the turnover, if it is not levied.

After service tax was imposed on forex transactions from May 16 last year, all banks started collecting a uniform fee of Rs 100 per transaction, irrespective of the value of the transaction, to protect their business from losses. Prior to that, banks did not charge a separate fee for this.

The revenue department had objected 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 as is the case with exporters, who keep on converting forex receipts into rupees.

Banks make a profit in forex transactions by charging a thin spread over the foreign currency. If the rupee is traded at 49.50 against the dollar, banks sell dollars above 49.50, but buy them at below this level.

Banks attempt to retain a margin while changing currency to cover the forex exposure risk due to daily price movements. Also, there are hundreds of transactions daily and it is difficult to keep track of gains or losses in each transaction.

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 trading are very thin.

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