Experts say govt will first have to build a clear tax and legal structure before attempting to recover money from such investors, as it may override, and in some cases, even violate bilateral tax treaties
Notwithstanding the showcause notices issued by the I-T department to various foreign portfolio investors (FPIs) and private equity firms for minimum alternate tax (MAT) violations, the applicability of MAT to such entities poses severe challenges.
Corporate lawyers and international tax experts FE spoke to said the government will first have to build a clear tax and legal structure before attempting to recover money from such investors, as it may override, and in some cases, even violate bilateral tax treaties with countries like Mauritius, Singapore, and the Netherlands, resulting in ‘unnecessary litigation’.
Pointing-out the dichotomy between Section 115 JB of the I-T Act and Schedule (VI) of the Companies Act, experts said FPIs are not required to maintain books of account as these entities have no permanent establishment in India.
On the other hand, Indian tax authorities believe that every company in India has to pay at least 20% MAT, irrespective of its location, type, or profitability status. However, to compute MAT, the starting point is to compute book profit based on the accounts prepared in accordance with the Companies Act, 2013.
The income-tax authorities reportedly issued notices to about 200-300 FPIs for assessment years 2008, 2009, 2010 and beyond. The notices mean that FPIs will have to pay tax at an effective rate of 20% on business income or ‘book profit’ with retrospective effect, replacing the capital gains tax framework.
Under the current regime, foreign institutions are not required to pay any tax on long-term capital gains (gains from investments exceeding one year). Institutions are liable to pay short-term capital gains tax (tax on investment less than one year) at 15%.
The tax department had also asked FPIs to furnish their profit & loss statements, balance sheets and other relevant documents, which are, otherwise ,submitted by companies based in India. FPIs are not liable to maintain books of accounts in India, according to various regulations.
Experts also cited past decisions by the Authority of Advance Rulings (AAR) in the case of Timken Co as well as and Praxier Pacific wherein it has been held that provisions of MAT may not apply to foreign companies. The Supreme Court also had pointed that in 263 ITR 716 (under Sections 4 and 5) subject to the provisions of the I-T Act, including Section 90.
“FIIs are not ordinarily bound by Indian company law. Applying MAT to foreign entities is a tricky issue. Implementation and application of MAT on foreign companies that are not presenting corporate accounts as per Indian company law to their shareholders globally is a challenge.
How do you make comparison between profits under the income tax law versus the company law in case of foreign entities? It will be difficult to make adjustments prescribed under Section 115 JB and raise additional demands in the absence of two separate set of accounts being followed by the taxpayer. Proper rationale and justification will need to be given to apply MAT merely due to non-applicability of capital gains tax or tax on business income,” said Sunil Jain, tax partner, J Sagar Associates.
If a Mauritius-based company opts for taxation in India under the India-Mauritius Tax Treaty, then its argument is that its taxability would be decided only under the treaty and there is no scope for applying MAT under Section 115 JB of the domestic tax laws of India. Therefore, it’s an income that, in accordance with the tax treaty, cannot be included in the scope of ‘taxable income’ and cannot form part of ‘book profit’ for levying MAT under Section 115 JB.
Sebi data show there are more than 8,200 FPIs registered in the Indian capital markets.
As on December 2014, Indian equities recorded the second-highest inflows (R4.3 lakh crore) from Mauritius-based FPIs, followed by Singapore (R1.65 lakh crore), and Luxembourg (R1.66 lakh crore). US-based FPIs top the list with fund flows worth R6.4 lakh crore.
FPIs encompass all FIIs, their sub-accounts and qualified foreign investors (QFIs) under a new regime that came into force on June 1, 2014. Representations to finance ministry
Various law firms and industry bodies have made representations to the finance ministry, seeking amendment to Section 115 JB of the I-T Act and clarify that tax may not be applicable to foreign companies having no permanent establishment in India.
While some sort of clarification by the FM in the Budget speech will help soothe investors’ concerns, experts demand a separate and detailed circular offering clarity. The government also needs to issue internal instructions ‘to go slow’ on FPIs until clarity on tax treatment is issued, which other would lead capital outflows, they said.
“The MAT question is more than two years old. The legal argument is that these companies (FPIs) have no permanent establishment in India and are not liable to pay MAT. Representations have been made to finance ministry for appropriate clarification, but since the matter of Castleton Investments on MAT is still sub-judice, the government may wait for the SC ruling in the matter,” said Sanjay Sanghvi, tax partner, Khaitan & Co law firm.
Indian markets saw net outflows of roughly $1 billion in the two months following the Budget 2012, in which the then finance minister, Pranab Mukherjee, introduced the General Anti Avoidance Rules (GAAR) with a view to increase tax collections. The quantum of outflows resulted in a 12% fall in the Sensex in those two months, data show.
Experts say at a time when the government is trying to attract foreign investment, it needs to do away with troublesome issues like retrospective amendments to tax laws.
“Foreign companies are willing to pay the rightful tax but they expect a stable and consistent policy. Specifically, the law should distinctly suggest that FPIs are not liable to pay MAT. Hence, we need a law that can be interpreted without any ambiguity,” said Ravi Kumar Shingari, partner – international tax and regulatory services, KPMG India.