CLSA: Prior years’ syndrome will hurt

By: | Published: April 21, 2015 12:11 AM

CLSA says if the courts finally uphold the claims of the I-T authorities, it will create operational chaos for FIIs as they will need to determine who will foot the tax bill

As anguish among foreign portfolio investors (FPIs) on the ‘retrospective tax’ regime in India continues to rise, an increasing number of brokers  term the issue of minimum alternate tax (MAT) as a potential risk. A week after foreign broking firm UBS cited the tax concerns among foreign investors as a red flag for Indian equity market, CLSA, in its latest strategy report, says taxes on FIIs  pertaining to prior years is likely to hurt sentiment.

Despite change in regime at the Centre, “Clearly, India is not completely out of the ‘tax claims pertaining to prior years’ syndrome yet”, says CLSA in the note.

Noting that the Vodafone tax issue severely impacted investor sentiments around India, CLSA predicts that if the current issue escalates, investor sentiment could get hurt again. It says that if the courts finally uphold the claims of the income-tax authorities, it will create operational chaos for FIIs as they will need to determine who will foot the tax bill.

It estimates that in the worst case, assuming half the FII funds (by value) are impacted by this case and going by the government’s estimated tax collection of R40,000 crore,  a 4% impact could be felt on the NAVs of these funds, if funds foot the tax bill. However the brokerage added that the stock market hasn’t yet reacted to these developments “ as only a few funds have received notices so far and the general expectation is that the issue will not escalate or the legal battle can go on for years”.

In the Budget, Union finance minister Arun Jaitley had made it clear that FIIs don’t have to pay MAT on capital gains from April 2015 onwards. But since then, there have been many instances of the I-T  department slapping notices on MAT liabilities for prior years.

The report also added that, “MAT (20% current rate) is a tax levied on ‘book profits’ of companies, which would, otherwise, pay much lower taxes due to various tax incentives and exemptions, etc. MAT would be applicable on short-term and long-term capital gains and interest income in this case. The potential tax liability could go back as far as FY09.”

Government officials are largely going by the precedent of the case of Castleton Investments, wherein the Authority for Advance Ruling (AAR) gave a verdict in August 2012, that Castleton is liable to pay MAT when it transferred shares from a Mauritius entity to a Singapore entity. The case is currently with the Supreme Court. If the Supreme Court upholds the AAR ruling, then the case of the income-tax authorities will become very strong.

If the SC strikes down the AAR ruling, the case will weaken considerably.  Jaitley has said the government could mop up R40,000 crore from these taxes, implicitly suggesting that I-T officials are acting with his approval.

“The taxpayers could potentially go to the Disputes Resolution Panel against these orders. DRP gives its verdict in nine months and tax liability, if any, will materialise only then. The option of going to the SC, ultimately, always exists,” concluded the report.

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