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Union Budget 2023 was the last approved budget regulating foreign remittances, and while some of its provisions were welcomed, it received criticism for increasing the TCS (Tax Collected at Source) from 5% to 20% for many transactions. This created liquidity challenges for many businesses, especially ones relying on international transactions.
Budget 2024, while still in its interim phase, is expected to relax many of its tax requirements, along with making it easier to make foreign stock investments. These new foreign remittance rules are expected to impact businesses in many ways and this article discusses what businesses can expect in the days ahead.
Profit from investing in stocks invites the long-term capital gains tax (LTCG) which was held at 20% for foreign stocks and 12.5% for domestic investments. This made foreign stock investments an unattractive option, not only because of the higher tax rate but also because of the fact that foreign transactions generally involve currency exchange fees and higher brokerage rates. The rationale for the higher tax rate was to encourage domestic investments, however, this is expected to change with Budget 2024.
The equalization of Long-Term Capital Gains (LTCG) tax rates for both domestic and foreign stock investments has made foreign equities a more attractive option for Indian investors. While the full economic impact of this new foreign remittance policy remains to be seen, it has generally been welcomed by the Indian investing community, which now has greater flexibility in diversifying their portfolios.
The tax rates on foreign remittances are governed by the Liberalised Remittance Scheme (LRS), launched by the RBI in 2004, which has since been regularly updated.
Currently, the TCS for foreign remittances is set at 20% for transactions exceeding 7Lakhs INR. This is applicable mainly to business and travel-related payments, while medical and educational expenses are covered under different tax schemes under the LRS. The 20% TCS rate is considered too high and its implementation was delayed until Oct 2023 due to practical challenges. It is expected that Budget 2024 will reduce the TCS back to its previous rate of 5%. This is mainly because a 20% TCS adversely affects the liquidity available for businesses, as a substantial sum is locked in under taxes.
A lower TCS rate allows the government to effectively monitor and regulate high-value foreign exchange transactions while maintaining robust tax compliance measures. This adjustment strikes a balance between providing liquidity relief for taxpayers and ensuring regulatory oversight in relevant financial matters.
Under the current scheme, non-reporting of foreign assets valued at more than Rs. 5 Lakh, invites a penalty of Rs, 10 Lakh. This is seen as counter-intuitive, as the penalty amount is more than the tax amount.
The new budget rules aim to ease this regulation by allowing the non-reporting of assets up to Rs. 20 Lakhs, meaning no penalty as long as the monetary value of foreign assets does not exceed 20 Lakhs. This makes tax compliance easier for businesses and individuals holding small foreign assets like ESOPS or social security/pension accounts.
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The possible reduction of TCS rates from 20% to 5% in Budget 2024 will significantly ease liquidity constraints for SMEs involved in international trade. By lowering the tax burden, businesses can free up capital for critical operations, such as inventory purchases and technological investments, improving cash flow and operational flexibility.
The relaxed remittance rules also make it easier for SMEs to explore global markets. Lower TCS rates and simplified compliance help SMEs to source materials, establish global partnerships and increase exports
For IT firms and tech startups that frequently engage in overseas contracts and projects, the lower TCS rate translates into more efficient capital management. Previously, the high TCS rates often tied up significant portions of their working capital, impacting cash flow and hindering their ability to invest in new technologies or scale operations. With the reduced rate, these companies can now retain more of their funds, allowing for greater flexibility in managing operational costs and pursuing growth opportunities.
The Manufacturing sector often relies heavily on international transactions for sourcing raw materials and purchasing equipment. This leads to a substantial amount of outward remittances. The new proposed TCS rates will help them retain the majority of their working capital, which was tied up in taxes under the previous regime. With the new lower rate, businesses in the manufacturing and export sectors can access more of their funds, improving cash flow and operational efficiency.
Overall, Budget 2024 is seen as a step in the as far as the new foreign remittance rules are concerned. Indian investors are happy with the reduced LTCG tax rates, while small foreign asset holders are pleased with the higher thresholds for asset reporting. The LRS which governs outward remittances from India is also expected to revert to older and lower TCS rates, which will free up capital that businesses can use for other investments and business ventures, boosting overall economic activity.
