Mumbai: Foreign exchange (forex) transaction costs for Indian companies rose starting Friday after the government raised the service tax on them. The rise in cost is as much as 50-fold—from Rs100 to Rs5,000—for a transaction of $1 million (Rs4.5 crore) or above.

Small and medium enterprises (SMEs) in particular will have to pay more for forex transactions, but those who undertake high-value deals, such as oil companies and airlines, will not be hurt that much as the government has capped the service tax at 0.01% of the gross amount of currency exchanged or Rs5,000, whichever is less, bankers and treasury dealers said.

Had the government gone ahead with its original plan, the burden on firms and individuals buying forex would have been much higher.

In its 1 March notification, the finance ministry had indicated that service tax would be imposed on 1% of currency exchanged.

Since service tax is pegged at 10.3%, this would have raised the cost of high-value transactions manifold. For instance, a $1 million transaction would have attracted service tax of Rs46,350 (1% of $1 million, or Rs4.5 crore, is Rs4.5 lakh; 10.3% of that is Rs46,350). In the original plan, there was no cap on the tax. This means, a $100 million transaction would have attracted Rs46.35 lakh service tax. (The rupee-dollar exchange rate has been assumed at Rs45.)

The Indian Banks’ Association, a national lobby group, had moved the government and the Reserve Bank of India seeking a review in the tax structure, following which the changes were made.

The latest government notification clarified that interbank transactions will be excluded from the tax net. This is a big relief for the forex market that sees a daily turnover of around $50 billion. But corporations and individuals buying forex from banks and money changers will have to pay the tax.

“For a $1 million transaction, there will be an additional cost of Rs5,000 to clients, which is a burden," said Anup Verma, group assistant vice-president (treasury) at Development Credit Bank Ltd.

Bankers will pass on the tax to the customers.

“This can impact liquidity in the foreign exchange market as corporations are the major participants," he said. “Any company will now th

ink twice before taking large trading positions and will stick to only basic hedging requirements. Ultimately, the market will have to suffer."

Till Thursday, most banks were charging around Rs100, regardless of the transaction, out of which Rs10.30 was paid as service tax.

If banks continue to levy transaction charges, in addition to the service tax, then the cost for customers will rise further.

Typically, firms buy and sell foreign currencies on a regular basis to hedge risks. They also buy as pure investment.

“Any cost increase is a pressure, but we will have to live with it," said Rostow Ravanan, chief financial officer at MindTree Ltd.

Individuals who buy foreign currency for overseas trips or supporting their children’s education abroad will have to pay more. For a Rs5 lakh transaction, they will have to pay Rs500 against a fixed rate of Rs100 (including service tax) earlier. The charge will rise proportionally up to Rs5,000, depending on the transaction value.

“The costs of the corporate world will increase," said Haresh Desai, director at AV Rajwade and Co. Pvt. Ltd, a forex consulting firm. “Even a medium-sized firm does about a hundred transactions a month. Most of the time, the transactions are more than Rs10 lakh. It is not a small value that they will have to shell out."

C. Chandrasekhar, senior vice-president at Mecklai Financial Services Ltd, another forex consulting firm, said the levy will hurt SMEs that are engaged in overseas trade. “For a large corporate, Rs5,000 may not be that big an amount, but for SMEs it is really a heavy burden," he said.

Axis Bank Ltd’s head of treasury, R.V.S. Sridhar, also sees small firms bearing the brunt of the charges.

Some forex dealers are concerned the tax will bring down trading volumes. “When you are talking about making Mumbai an international financial centre, these kind of taxes only make it difficult to achieve that," said Chandrasekhar.