Given how FIIs own nearly 21% of India’s stock market (47% of floating stock) and drive the Sensex—witness how the index collapsed when on GAAR fears in 2012, FIIs started selling—it is truly amazing that the issue of MAT on FIIs has been allowed to proceed in the manner it has. Minister of state for finance Jayant Sinha’s statement that the government is considering issuing a clarificatory amendment on the applicability of treaty benefits—this will allow a large number of FIIs to escape the R40,000 crore tax, the rest will have to go to court—has hopefully taken off some of the heat, but the important question for finance minister Arun Jaitley is how the situation was allowed to come to this pass, and how he was incorrectly briefed. As a result of this briefing, Jaitley went and publicly defended the tax notices, including when he was overseas, and argued that the foreign investors had lost the case at the Authority for Advance Ruling (AAR) and so had to pay the tax. Though the budget had clarified that MAT would not be levied on FIIs, Jaitley said what investors wanted was a retrospective application of the law—he didn’t say, but it was implied, the same investors had been opposed to the UPA’s retrospective tax legislation. After saying India was not a tax haven, he said the money could, for instance, transform the irrigation sector, underscoring the government’s seriousness in pursuing the case.
The problem is that the finance minister was incorrectly briefed. The case on MAT is hardly as cut and dried as made out. There is no confusion over the fact that if an entity has a ‘permanent establishment’ in India, MAT can be levied on it. The issue has been about whether companies who do not have a ‘permanent establishment’ can be charged MAT. The problem is the AAR that the finance minister talked of has given contradictory rulings on the applicability of MAT. In the case of Timken in 2009, the AAR said that no MAT could be charged since the firm did not have a permanent establishment in India. The same logic was applied to Praxair Pacific in 2010. In the case of Castleton (incidentally, it is not an FII), however, the AAR said MAT could be levied even though there was no ‘permanent establishment’. In the case of the Bank of Tokyo Mitsubishi, in 2010, the AAR however ruled that no MAT was applicable even though the bank had branches in India—under the double taxation avoidance agreement (DTAA), these constituted a ‘permanent establishment’. In this case, AAR ruled the taxable income had been computed as per Article 7(3) of the DTAA and so were exempt. With multiple rulings pointing in different directions, at the level of the Board at least, an alert should have got thrown up on the need for a larger review of the applicability of MAT, more so given the size of the notices and their potential implication—the same lack of thought appears to have taken place at the time Pranab Mukherjee introduced the retrospective taxation proposal in 2012.
Given this unfortunate history with the taxman, the government needs to find a foolproof way to ensure proper supervision and review of tax orders. It is also curious that if treaty benefits are to be extended now, surely this should have been an option presented to the finance minister earlier and exercised before matter spiralled out of control? At this point, some tough questioning should be taking place at both the level of the finance minister and at the level of the prime minister since the episode gives the impression the tax department is a law unto itself.