UNDERSTANDING THE RECENT AMENDMENT IN TAX COLLECTION AT SOURCE WITH RESPECT TO FOREIGN REMITTANCES

[Dhanush Thonaparthi]

Planning to spend a vacation abroad in the vacations? Decided to buy something you’ve always wanted that just got released abroad? Then don’t think twice about it! Think thrice.

The Government has increased the rate of Tax Collection at Source (TCS) from 5% to 20% with respect to foreign remittances made using the Liberalized Remittance Scheme (LRS).

The first part of this article will provide a basic understanding as to what TCS and LRS mean. The second part of the article discusses the importance of the LRS scheme. The third part of the article discusses the potential benefits of the amendment while the fourth part of the article discusses the drawbacks of this amendment. The article then meaningfully concludes.

What is tax collection at source and the Liberalized remittance scheme?

Tax collection at source is essentially an extra amount collected as a tax by the seller of goods from the buyer when the sale is made, over and above the sale amount, which is then remitted to the government account.

TCS with respect to foreign remittances is covered under Section 206C (1G) of the Income Tax Act, wherein TCS is collected at the rate of 20% as per the recent amendment, by an authorized dealer or the seller of an overseas tour program package when they receive an amount from a buyer or when the amount is debited by the buyer, whichever is earlier.s

The Liberalized Remittance Scheme, simply put, is a scheme introduced by the RBI to ease the process of remitting funds abroad. Under this scheme, all (and only) resident individuals are allowed to remit up to two hundred and fifty thousand dollars, or its equivalent, freely, every financial year, for the purpose of any expenditure or any investment.

Earlier, before October 2020, it was relatively easier to remit funds under LRS. A person wishing to remit any money abroad, had to approach his bank, fill up the A-2 form, specify as to what purpose the remittance is being made and sign a declaration. Then all that was left was for the funds to be transferred.

By virtue of the Finance Act 2020, provision (1G) in Section 206C of the Income Tax Act 1961 was introduced, which imposed TCS at the rate of 5% on foreign remittances via the LRS scheme.

By virtue of the Finance Act 2023, the rate of TCS was increased from 5% to 20%. Additionally, a slight relief was allowed for foreign remittances made for the purpose of medical treatment or education, with there being no TCS for any foreign remittance up to seven lakh rupees and in case any foreign remittance for the purpose of medication treatment or education exceeds seven lakh rupees, the rate of TCS will stand at 5%.

So why bother with the LRS scheme?

Now while the proviso is worded such that amounts transferred under the LRS scheme only are taxed and not all foreign remittances in general, it is important to consider the fact that before the LRS scheme seeks to liberalize the foreign exchange regulations for individual residents of India, so as to help facilitate effortless transfer of money abroad.

The LRS scheme allows Indian residents to make international investments without having to deal with the inconvenience of getting multiple permissions from the RBI. It is also handy when a resident individual needs to remit an amount to a relative or friend abroad in case of an emergency where there is an urgent need for funds as there is a lower regulatory framework to overcome for a transaction via LRS, making it more speedy and convenient.

With this context in mind, the amendment increasing the TCS rate to 20% is more important and its consequences more influential, which shall be discussed in the next section

Advantages of the increase in TCS rate

Shift towards domestic spending - the push to spend in India

A natural consequence of foreign remittances becoming expensive is thatconsumers will seek to find alternatives within the country. The increase from 5% to 20% is a substantive increase in the tax rate, which will affect the way that consumers spend on foreign products and services.

This can be understood using the economic concept of the substitution effect. If spending by a product becomes more expensive, consumers will seek cheaper alternatives.

Here, the products or services that consumers acquire from aborad become more expensive because of the increase in tax rate. While there are exemptions available for expenditure with respect to education and health expenses, most other foreign remittances with respect to other items such as tourism or purchasing property abroad will be subject to the higher rate of 20%.

Additionally, expenditure on such items can lead to a decrease in the foreign exchange reserves of India and this move can be seen as a protective measure to prevent depletion of foreign reserves over non-essential items. This also ensures that the wealth is circulated within the domestic markets, benefitting the domestic players over foreign ones.

Increase in tax revenue - more tax = more money

Taxation is the only practical way through which government can raise revenues for its expenditures. So if a government wants more money, a seemingly simple solution (while it is obviously not that simple), is to increase the tax rates.

By increasing the tax rate from 5% to 20%, assuming that the obvious reduction in foreign remittances does not happen, there is bound to be a an increase in tax revenues for the government.

But it is logical that there will be lower if not similar tax revenues upon an increase in tax rates. But as discussed earlier, more money is spent within the markets and government ends up earning more tax revenue than before despite overall lower remittances as the government is able to collect more GST because now there is more money spent in domestic markets for goods and services, which was otherwise spent abroad.

The Drawbacks of an increase in TCS rate

Legislative intent for the increase in rate - or the lack of it

A singular problem that stands out with respect to the entire scheme of increasing the TCS rate on foreign remittances is a lack of clear legislative intent. The insertion of proviso (1G) to the Income Tax Act was originally done to widen the tax base. While imposing TCS on foreign remittances in and by itself is problematic for reasons mentioned below, there seems to be no clear legislative intent as to why the TCS rate made a drastic jump from 5% to 20%, outlined in either the memorandum to the Finance bill, or in the notes to the clauses of the Finance Bill, leaving it open to further scrutiny and controversy.

Defeats original legislative intent - a true paradox

An increase in TCS rates on foreign remittances can also push people to find informal and illegal sources of transfer the remittance amount, especially if they are poor workers in India. This leads to increased litigation and a loss of potential tax revenue due to an exorbitant rate of TCS on foreign remittances under the LRS route, which runs contrary to the original intention behind imposing TCS on foreign remittances, which is to widen the tax base, as outlined in the memorandum to the 2020 Finance Bill.

The technical hitch - more unnecessary complication

Apart from the more general arguments on legislative intent, there are more specific reasons as to why imposing TCS on foreign remittances itself is problematic, with multiple problems since its inception. Firstly, TCS is not an additional tax. It is credited to the payer’s account and adjusted against their tax liability. For adjusting against TCS, the buyer will have to spend an extra amount to account for The TCS rate and then further, if the transaction has already been subjected to an advance tax or tax deduction at source (TDS), then the assessee in question will have to claim the excess TCS as a refund when they file their tax returns and the money will be blocked without any interest, till the refund is processed and completed.

International consequences - a dilution of international commitments

Looking at this issue in a more international context, a tax on remittances in general raises the cost of remittances, which is in contravention to United Nation’s Sustainable Development Goal of decreasing costs of remittances, in relation to UN SDG 10 on reducing inequalities. It also contravenes India’s G20 commitments of reducing remittance costs for workers.

Additionally, imposing TCS on foreign remittances can amount to double taxation. Sometimes, when a migrant in India remits an amount to his country of origin, the income so remitted may be subject to additional tax, subject to the domestic laws of his country of origin. By taxing the transfer of money up to 20%, it amounts to double taxation for honest tax paying migrants situated in India. In India itself, inbound foreign remittances over and above fifty thousand rupees, made to somebody not related by blood, is taxable in India.

Conclusion

We have seen how TCS is charged for any foreign remittances made via the LRS scheme and why the LRS scheme is important. While there may be an advantage on increasing the TCS rate from 5% to 20%, the problems that flow from it are far more severe, ranging from potential violation of international commitments to an inherent flaw in the structure itself which puts the assessee at an unnecessary inconvenience. The effort must be to do away with it altogether or reduce TCS on foreign remittances in line with international commitments and for other mentioned reasons which have far more importance than a narrow goal of widening the tax base or increasing tax revenues.