Tax on international credit card transactions: rationale and challenges – Explained, pointwise

Introduction

The recent imposition of tax on international credit card transactions has stirred discussions. This new policy aims to address the disparity between debit and credit card transactions abroad and prevent bypassing of Liberalised Remittance Scheme (LRS) limits.

However, it brings with it certain complexities. While aiming to enhance transparency and ensure prudent foreign exchange management, the tax also raises concerns about the increased financial burden on consumers and potential implications for cash flow. This makes it imperative to explore the rationale behind this move and the challenges it poses.  

What is the rationale behind the Tax on international credit card transactions?

High foreign exchange outflows: International credit card transactions result in an outflow of foreign exchange from the home country. If this spending is high or uncontrolled, it could potentially strain the country’s foreign exchange reserves. By imposing a tax, the government aims to discourage excessive spending, helping to manage foreign exchange resources effectively.  

Tax evasion: A tax on international credit card transactions helps ensure tax compliance and prevent tax evasion. Prior to this, there was a potential loophole where individuals could make large purchases abroad, which were not counted towards their taxable income in their home country.  

Inequality between debit and credit card transactions: International transactions made through debit cards were already accounted for under the Liberalised Remittance Scheme (LRS) limit. However, the use of international credit cards for expenses abroad enjoyed an exemption and was not counted under the LRS limit. This created a disparity in the treatment of debit and credit card transactions. The introduction of the tax on international credit card transactions aims to address this differential treatment.  

Fiscal Inequity: By levying taxes on international credit card transactions, governments aim to ensure fiscal equity, meaning all types of income (including gains from foreign transactions) are taxed similarly.  

About Tax on international credit card transactions

Introduction to Tax on international credit card transactions: The government has imposed a tax on international credit card transactions. This tax is known as the Tax Collected at Source (TCS) and it applies when spending through credit cards crosses certain limits under the Reserve Bank of India’s Liberalised Remittance Scheme (LRS).  

Liberalised remittance scheme (LRS): Under the LRS, resident individuals can freely remit up to USD 250,000 per financial year for permissible transactions. Previously, international credit card spending was not accounted for under this limit. However, recent changes now bring this spending under the scope of LRS, effectively creating parity between the usage of debit and credit cards abroad.  

Changes in the Tax rate: Now TCS rate will be 20% on foreign remittances that exceed the annual LRS limit of USD 250,000. This is an increase from the previous TCS rate of 5%.  

Exemptions from the Tax: Notably, the new provisions do not apply to payments for ‘education’ and ‘medical’ purposes and do not affect the use of international credit cards by residents while in India. IT sector workers travelling on business trips will not be affected by the new provisions.  

What are the expert’s opinions about imposing Tax on international credit card transactions?

What are the advantages of imposing Tax on international credit card transactions?

Promoting financial transparency: The imposition of tax on international credit card transactions under the Liberalised Remittance Scheme (LRS) promotes financial transparency. This is because all transactions exceeding the annual limit of USD 250,000 now have to be reported and taxed.  

Elimination of disproportionate spending: The measure aims to prevent disproportionate overseas spending through credit cards when compared to an individual’s disclosed income. It helps in keeping a check on disproportionate high spending that is not in line with the income disclosed by the users.  

Enhanced revenue for the government: By taxing these transactions, the government can generate additional revenue. The increase in Tax Collected at Source (TCS) from 5% to 20% potentially provides a substantial increase in government revenue.  

Preventing misuse of foreign exchange: The tax on international credit card transactions aids in the prudent management of foreign exchange by discouraging unnecessary or excessive foreign transactions. It prevents individuals from bypassing the LRS limits and potentially misusing foreign exchange.  

Encouraging responsible spending: The tax imposition encourages individuals to be more responsible and judicious about their overseas spending using credit cards. It might incentivize some individuals to reduce unnecessary overseas transactions and manage their finances more effectively.

What are the challenges faced in imposing Tax on international credit card transactions?

An additional burden on users: Imposing taxes on international credit card transactions adds an additional financial burden on card users. The Tax Collected at Source (TCS) increase can substantially add to the costs of overseas transactions.  

Complicated compliance process: The implementation of these tax rules may make the compliance process more complicated for both the users and the financial institutions. Capturing and reporting all such transactions could be a complex process, particularly when it involves international transactions.  

Risk of reduced spending: The increased tax burden may discourage individuals from spending overseas or using international credit cards. This could have an impact on the revenue of credit card companies and banks, and potentially affect the overall spending in the economy.  

Unclear guidelines: Currently, the guidelines regarding the tax on international credit card transactions are still being developed. There may be some ambiguity and confusion among card users and financial institutions until clear and detailed guidelines are released.  

What should be done?

Detailed guidelines: The Reserve Bank of India (RBI) and other relevant authorities should provide detailed guidelines and clarifications about the tax rules on international credit card transactions. This will help in the effective implementation of the rules and alleviate any confusion or ambiguity.  

Incorporation of technology: Financial institutions can incorporate technology to automate the process of capturing and reporting transactions subject to the new tax rules. This can help in the efficient implementation of the rules and also ease the compliance burden on the institutions.  

Clear communication and education: The government and financial institutions should communicate these changes effectively to all stakeholders, especially cardholders. They should explain the new rules, the rationale behind them, and how they will affect the users’ transactions.  

Review and feedback: The government should regularly review the impact of these tax rules and consider feedback from stakeholders. If the rules are causing significant inconvenience or financial burden, then necessary adjustments should be made.  

Strategic planning: Users of international credit cards should strategically plan their expenses and usage to ensure that they stay within the permissible limit of the LRS. They should also factor in the additional tax burden while planning their international spending. 

Sources: Business Standard, Indian Express, Livemint (Article 1 and Article 2), Finshots, Outlook India, The Hindu Businessline, Hindustan Times and Economic Times 

Syllabus: GS 3: Economic development: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.