The controversy on FIIs/FPIs—with 68 cases and Rs 603 crore for levy of minimum alternate tax (MAT)—has been put to rest with the finance minister affirming the recommendations of AP Shah committee’s report that MAT shall not apply to FIIs/FPIs for the period prior to April 1, 2015.
Section 381 of the Companies Act, 2013 (earlier Section 591-594 of the Companies Act, 1956), specifies that only foreign companies are required to create a balance sheet and profit and loss account in such form containing such particulars as prescribed. Section 2(42) defines foreign company to mean any body corporate incorporated outside India which (1) has a place of business in India whether by itself or through an agent physically or through electronic mode and; (2) conducts any business activity in India in any other manner.
Thus, for the applicability of MAT on FIIs/FPIs—being a company or body corporate—the existence of permanent establishment (PE) is a must. FIIs/FPIs do not have any office or employees of their own in India. They take all investment decisions outside India. As mandated by Sebi, the purchase and sale of securities happens through a registered stockbroker. From various court rulings, a clear distinction can be drawn as to “carrying of business” versus “established place of business”. Only if a person has a permanent and specific location in that country from where he habitually and regularly carries on the business, it shall be termed as PE in that country.
The report articulates that Section 115JB, being a self-contained code, has the chargeability and method of computation within itself. Both have to be read together rather than in isolation to draw a conclusion. The requirement of drawing up the financials as per Companies Act should exist. Only then the question of MAT comes into the picture. Sebi regulations do not mandate maintenance of books of accounts by FPIs/FIIs as per Schedule VI of the Companies Act.
The AAR ruled that Castleton Investments, a company resident of and incorporated in Mauritius, be subject to MAT liability. It was stated that Section 115JB cannot be confined in its application to domestic companies alone but include foreign companies as well. This is categorically rejected by the committee that income from long-term capital gains under Section 10(38) shall not apply as Section 115JB itself is not applicable in the first place. In Praxair Pacific and Timken, the AAR held that where a foreign company has no PE/place of business in India, Section 115JB shall not apply and treaty benefits will be available. The committee has not commented about these decisions in the report.
The report states that “company” as per Section 115JB covers only those prescribed under the Companies Act. Inclusion of foreign income in the book profits is contrary to the principle of territorial nexus, in GVK Industries versus ITO and Ishikawajima-Harima Heavy Industries versus DIT Mumbai.
Electricity, banking and non-life insurance companies did not fall within the purview of Section 115JB because they prepared their profit and loss accounts in accordance with their regulatory acts; Section 115JB(2), Explanation 3 got inserted in Finance Act, 2012, to consider the book profits as drawn by these companies for MAT computation. No such regulatory requirement exists for FIIs/FPIs to tax their income which is effectively connected outside India.
The Supreme Court held that when there is a case to which computation provisions cannot apply at all, the case is not intended to fall within the charging section. For FIIs/FPIs, when there is no regulatory requirement to prepare financials as per Companies Act, the question of MAT levy does not arise.
The government has committed to amend the law not to make FIIs/FPIs subject to MAT liability in the coming session of Parliament, but only until some other view crops up.
In a recent Mumbai Tribunal judgment in the case of Shivalik Ventures versus DCIT (Mum), it was held that profits arising on transfer of development rights to the fully-owned subsidiary company are not required to be included in the book profits under Section 115JB of the Income Tax Act, 1961. A legal proposition found merit before the Tribunal that, when a holding company transfers a capital asset to its subsidiary as per Section 47(iv), it shall not be subject to tax under Section 45. Extending the argument, if a transaction is not subject to tax, then it is not an income as per Section 2(24).
The company derived a surplus over cost of acquisition of assets held by it as capital work in progress (CWIP) amounting to R300.24 crore. In view of the fact that it is a capital receipt and not regarded as “income”—Section 2(24) of the Income Tax Act—it reduced the same from the book profits for the purpose of MAT calculation. The assessing officer recalculated MAT liability, increasing the surplus earned as part of the book profits and the commissioner (appeals) also confirmed.
A similar case of Rain Commodities versus DCIT, before the Hyderabad Tribunal, held that in the absence of any provision for exclusion of capital gains in the computation of the book profits under Section 115JB, the assessee is not entitled to exclusion from the book profits. However, the distinguishing fact in the Shivalik Ventures case was that the assessee clearly mentioned why it has excluded the surplus earned in the notes to accounts which forms part of the profit and loss account.
The Delhi High Court, in the case of CIT versus Sain Processing and Weaving Mills, held that the assessee, having prepared the profit and loss account under Part II and III of Schedule VI of the Companies Act, 1956, without charging depreciation in the profit and loss account but disclosed by way of a note in the notes to accounts computed in accordance with Section 205(2) of the Companies Act, is entitled to deduction from the net profit to arrive at the book profits.
MAT being an alternate tax to normal tax should stick to its objective of taxing zero tax paying companies by applying a percentage on the book profits as shown in the profit and loss account. Unfortunately, the more simpler we assume a tax provision to be, the more complicated it turns out to be.
The author is executive partner, Lakshmikumaran & Sridharan