How to make BCs more viable

Fabrizio Valenti | Updated on August 13, 2021

Exempting all Business Correspondents from TDS and applying nil GST rate to all transactions performed by them will help

At the end of a long day of work, Rajendra, a construction worker from Bihar, leaves his worksite in Delhi and heads to a local kirana shop that doubles up as a Business Correspondent (BC). He buys some snacks and sends ₹1,000 in remittances back home. Only a few years ago to do the same he would have had to go to a bank, losing a full day’s wages, or, more likely, he would have resorted to informal channels.

There is no ATM nor a bank branch in his village, but his wife, Aditi, can safely and quickly withdraw the money Rajendra sent her from a local Business Correspondent. The BC has also helped her access Covid-19 relief packages that were credited to her PMJDY account a few months after the outbreak of the pandemic.

Over 1.1 million BCs perform millions of such transactions every day all over India, bringing essential financial services to under-banked and unbanked citizens. The transformative potential of these last-mile facilitators is evident especially in rural India — where less than 100,000 ATMs and commercial bank branches can be found, against over 540,000 BCs.

It should not be a surprise, then, that in April 2020 they were recognised as essential service providers and, in April 2021, as “front-line Covid warriors” to be prioritised for vaccination.

In line with its financial inclusion strategy, the RBI has adopted a policy direction that clearly demarcates an intent to strengthen, expand, and support the BC model. However, a policy note recently published by LEAD at Krea University argues that two key taxation issues are hindering the sustainability and attractiveness of the BC model — the application of tax deducted at source (TDS) on cash withdrawals and the Goods and Services Tax (GST) on financial transactions conducted by BCs.

Tax deducted at source

For citizens who have not filed income returns every year for at least three years, which is rather common in low-income settings, the Income Tax Act mandates the deduction of 2 per cent TDS on cash withdrawals if the aggregate amount withdrawn by the recipient in the previous year is between ₹20 lakh and ₹1 crore.

On the other hand, if that amount exceeds ₹1 crore, the TDS deduction rate increases to 5 per cent. The Act makes explicit provisions stating that these regulations would not apply to “any business correspondent of a banking company”.

Yet, the application of this clause is controversial in instances where the BC is affiliated to a bank that is different from the one where the cash withdrawal is conducted, which is typically the case in rural areas.

A simple clarification from the Ministry of Finance stating that the TDS exemption applies to any business correspondent of any banking company or co-operative would guarantee that the intent of the legislator is applied to its full extent. In the absence of this clarification, BCs may stop serving the customers once they hit the first TDS ceiling of ₹20 lakh or suffer a significant capital blockage.

The introduction of GST in 2017 marked a significant advancement in India’s tax mobilisation capacity. At the same time, the idea was to build a system that did not create an unfair burden on the poorer population segments — as demonstrated by several provisions.

For instance, services provided by a BC for accounts in rural areas and PMJDY accounts are subject to a nil GST rate. In most cases, it is impossible for citizens and BCs to avail themselves of the benefit of this provision.

This is because a BC cannot determine whether the bank accounts that they service are rural or urban, since transactions conducted through IMPS only require the IFSC of the banking institution.

This leads to an unintended inclusion error; as the IMPS system is blind to whether an account is rural or urban, GST is charged on all transactions, diluting the intent of the policy. Solving this issue from the technical side is complex and time-consuming.

Meanwhile, applying a nil GST rate to all banking services performed on NPCI platforms offered at BC agent outlets would fix the problem and help realise the intent of the regulator, since BCs are normally used by the poorer strata of the society.

An issue of value added: For some interoperable services like remittances, it is not possible to charge fees directly to the issuer bank (unlike, for example, AEPS and transactions on NPCI platforms). In these cases, banks directly collect fees from customers via BCs, inclusive of GST.

Subsequently, banks pay a fee on the same service, also susceptible to GST, to the Corporate Business Correspondents (CBC) to which the BC agent belongs, and, again, the CBC will pay a commission to the agents, which will also have a GST component. This system shows a clear value-addition issue. The fee paid by customers includes the value added to the transaction, not only by the bank, but also by the CBC and the BC agent.

In this light, it can be argued that GST is being charged multiple times on the same value addition as it is levied on the overall fee paid by the citizen and then again on the fee paid by the bank to the CBC, and from the CBC to the BC agent.

There is a need for the RBI to examine whether the current implementation of GST regulations duly follows the principles of value-added taxation since it appears that GST is currently being overcharged on certain transactions performed by BC agents.

BCs play an essential role to bring financial services to the poorest citizens and under-banked regions of the country. The following three recommendations will help improve the viability of BCs :

Ensure that all BCs are exempt from TDS

While looking for a technical solution to distinguish accounts belonging to urban and rural accounts, apply a nil GST rate to all transactions performed by BCs.

Examine whether the current implementation of GST regulations follows the principles of value addition and consider whether allowing agents to directly charge fees, within the limits prescribed by the RBI, would help fix this issue.

Addressing these ambiguities in TDS and GST application through the implementation of the proposed recommendations, can pave the way for improving the viability and sustainability of the BC model in India, and advancing the government’s financial inclusion agenda.

The writer is Head - Financial Inclusion, LEAD at Krea University

Published on August 13, 2021

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