As anticipated, the recently released Justice AP Shah panel report strengthens the government’s resolve to put to rest the contentious issue of the imposition of minimum alternate tax (MAT) on foreign institutional investors (FII). Its prompt acceptance by the government undoubtedly communicates a firm message to the international community that it is willing to make changes to dispel the concerns on retrospective taxation.
The vexed issue of levy of MAT on FIIs arose due to an ambitious interpretation by the administration. While the primary issue with such levy and its validity has been a subject matter of a writ before the Mumbai High Court, the administration justified it by drawing from the order of the Authority for Advance Rulings (AAR) in the case of Castleton. Revenue had appealed at the Supreme Court against other orders of AAR which favoured the foreign companies’ stand in the matter. With the MAT-levy, most FIIs and FII associations skipped the administrative appeals option and instead sought constitutional remedy by filing writs at the high court level, and ultimately, at the apex court level.
An interpretational aspect on levy assumed significance after the introduction of Section 9A to the Income Tax Act (vide Finance Act, 2015), which clarified that having an investment fund manager will not render an FII to be deemed as having a place of business in India, the condition that triggers applicability of MAT. The said amendment was a progressive approach that encourages the presence of a fund manager in India to bolster FII investments without the latter having to worry about onerous tax obligations such as MAT—a demand the FII fraternity has raised with successive regimes at the Centre.
The interpretation by the taxman that the amendment is effective only April 1, 2015, onwards was erroneous on various counts. First, FII taxation has been in the statute since 1993, and the levy of MAT has never been a matter of debate. A simplified FII taxation, by way of fixed capital gains tax levy, was put in place by the law-makers to provide not just certainty to encourage flow of foreign funds, but enable fund managers to compute the precise return on investments for investors in such funds. The tax administration’s argument for MAT on foreign companies in general (those that aren’t FIIs) was dismissed by the AAR (in the Timken and Praxair cases) and Revenue did not by pursue appealing to higher courts, thereby indicating its finality.
An interpretation of Section 9A ought to be read as clarificatory in nature and nothing more. Courts have successively held that even if a clarification is prospective, it is supposed to be declaratory and has retrospective applicability. The argument that FIIs being exempt from MAT does not apply retrospectively is meaningless if the 2015 amended law itself is to be read as clarificatory. An argument that a similar case with respect for levy of MAT on a foreign company—Castleton is not an FII—is before the SC also did not justify MAT levy on FIIs. The matter before the SC against the AAR order is applicable to facts of Castleton and not binding on other foreign companies and certainly not on FIIs, which are subject to an independent tax regime.
That said, the government in its wisdom felt appropriate to constitute a committee chaired by Law Commission chairman Justice AP Shah. The key issues which Shah Panel examined were whether the MAT provisions extended to foreign companies, whether the FIIs could be considered to have a place of business in India notwithstanding that they do not have physical presence, and whether MAT provisions override the provisions of double taxation avoidance agreements.
Having analysed the legislative history and intent behind MAT, the panel concluded that MAT cannot be levied on FIIs. In doing so, it observed that MAT levy was introduced to plug an abuse by book-profit-making companies declaring dividends but not paying corporate tax due to tax concessions. Such intent was evident from successive Budget speeches, circulars issued by the CBDT explaining its introduction and numerous amendments. The panel reasoned that the MAT provisions would not apply to companies which do not have a place of business in India.
Since FIIs do not have a place of business in India and carry out their decision-making activities overseas (a concession made in 2015 budget to encourage fund managers to be present in India), the panel concluded that there cannot be a case for MAT levy. The panel concluded that MAT provisions cannot override the benefits under the tax treaties.
The committee has recommended amendments to the law and clarifications indicating the inapplicability of the MAT provisions to FIIs prior to April 1, 2015. It recommendations have been accepted by the government, and as an immediate relief (pending amendment to law), the Central Board of Direct Taxes has issued instructions to its officers to keep the proceedings in abeyance.
Interestingly, the committee has stopped short of recommendations on applicability of MAT on other foreign companies. Besides, nothing precludes a foreign company which doesn’t have a place of business in India from taking a position based on the panel’s recommendations. It should, however, not deter the government from treating non-FII foreign companies on the same footing as FIIs, thereby burying the entire debate. The implications of MAT controversy is a good reason for the government to conduct a comprehensive review of taxation of capital markets transaction. The Shome panel in 2013 made some useful recommendations, including a simplified regime and consistent tax rates agnostic to status of investors1institutional or private, domestic or foreign. I trust these recommendations will find way in successive budgets, given the importance of institutional investors to the growth of Indian capital markets.
With inputs from Raghunath Rao
The author is partner, BMR Legal. Views are personal