The government said that service tax on foreign exchange transactions would be capped at Rs 5,000. The announcement will provide relief to market participants who feared high tax incidence would lead to a sharp decline in foreign exchange transaction volumes.
According to a notification, tax for foreign exchange transactions will be calculated at 0.1 per cent of the gross amount of currency exchanged for up to Rs 1 lakh. The minimum tax will be Rs 25.
For Rs 1-10 lakh transactions, the tax rate will be Rs 100, plus 0.5 per cent of the gross amount exchanged.
For transactions above Rs 10 lakh, the service tax rate has been fixed at Rs 550, plus 0.01 per cent of of the gross amount of currency exchanged. But the maximum amount of service tax will not exceed Rs 5,000.
Since May 2008, all foreign exchange transactions have been subjected to service tax. So far, bankers used to charge a service fee of Rs 100 per transaction, on which service tax was levied at 12.36 per cent.
So, effectively a person doing foreign exchange trade was paying Rs 112.36 as service charge (including tax) each transaction.
However, in the Union Budget for 2011-12, the government proposed new methods to calculate service tax for foreign exchange transactions.
Under the first method, service tax will be imposed at 0.1 per cent of the gross amount of currency exchanged.
In the second method, service tax will be one per cent of the difference between buying/selling rate and the Reserve Bank of India's reference rate for the day multiplied by total units of the currency.
Bankers said this would have increased the tax burden, which ultimately is borne by the customers.
"We work on wafer thin margins. So, the announcement comes as a relief for us. Otherwise, transactions volumes would have taken a hit making our business unviable," a senior official at a private bank said.
