Overseas pension funds, particularly those based in the US, now face a tax demand in India. The Authority for Advance Ruling (AAR), a quasi-judicial body, last week dismissed a miscellaneous application by General Electric Pension Trust (GEPT) for reconsideration of an earlier ruling, which said the American trust has to pay tax in India.

The AAR ruling was keenly awaited by the FII community in India as the order could reopen the tricky issue of taxability of foreign portfolio funds’ income in the country. The ruling may also come as a setback to foreign pension funds. GEPT is a $43-billion fund with $80 million invested in India.

The income-tax department has reopened a number of FII assessments, where the funds have invested in India directly from their respective home countries without routing through places like Mauritius, which has a double taxation avoidance pact with India.

The dismissal of the petition, if eventually upheld by higher courts, would result in the department imposing a 41.5% tax on FIIs’ net profit. This is the same rate that applies to the Indian branches of MNCs.

The miscellaneous application was against an earlier AAR order, delivered in 2005. While AAR rulings are binding only in specific cases, such orders often influence assessing officers. Dinesh Kanabar, partner of consultancy firm RSM, which filed the application on behalf of GEPT, said, “AAR dismissed our petition last week. But I have not yet got a copy of the order and until I have the order in my hand I would not be able to comment”.

AAR, in its original order, had concluded the FII was not eligible to be considered a resident of the US for the purpose of taxation since it enjoys tax exemption in that country. Therefore, it is not entitled to tax benefits accorded under the double taxation avoidance treaty (DTAA) between the US and India. The ruling could apply to other entities, which enjoy tax-exempt status in the US.

TP Ostwal, an expert on international tax issues, said, “Similar views have been taken by judicial authorities in France and Japan in cases involving collective investment schemes. The OECD is yet to resolve the issue, which is being actively debated”.

In the present case, GEPT was ready to show that it was a tax resident of the US by producing a certificate from the Philadelphia revenue authorities. But since the certificate was originally procured to be produced in Australia, AAR said it could not recognise a third party evidence.

The question of permanent residence was raised by GEPT. It said it does not have a permanent residence and since what it earned from India was in the nature of “business income”, under the provisions of the India-US treaty, it was eligible for exemption from taxation in India.

The rationale for the income-tax department was that since GEPT (being a trust) is not paying tax in the US, it is taxable in India from where it generates income.

AAR, in its original ruling, held the profits accruing to GEPT from the sale of portfolio investments in India will be treated as business income. Since GEPT is not entitled to avail the benefits of the Indo-US tax treaty, the business income of GEPT will be taxable under the Indian I-T Act. AAR had also observed that nothing was produced before it to show the object of the investment in shares of Indian companies was to derive only income by way of dividend.