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Tax department issues show-cause notices to over 35 foreign portfolio investors
January, 12th 2015

At a time when the government has promised a more predictable tax regime as well as a far less aggressive one than under the previous administration, several foreign portfolio investors have been alarmed by moves to levy minimum alternate tax (MAT) on their capital gains from the market.

Revenue officials in the Mumbai tax department issued show-cause notices to more than 35 foreign portfolio investors (FPIs) last month, triggering panic over fears of dented profit. Similar notices were sent in September as well, but to fewer investors. Industry experts said there are around 8,000 FPIs in India, of which as many as 6,000 could face MAT threat.

A show-cause notice is not an indictment but asks the recipient for an explanation — in this case, the taxman wants to know why the FPI isn't liable for MAT. The move has sent such investors rushing to tax consultants including PwC, Deloitte, EY and KPMG.

MAT is Levied at About 20%

Many of the consultants are critical of the department's move. MAT is a domestic levy applicable only on India-based manufacturing companies, said one consultant. "There is no new provision; an existing provision is being interpreted adversely and could affect the FPIs," said Ketan Dalal, senior tax partner, PwC India.

The government has been pledging a less predatory and more predictable tax environment after investor sentiment turned negative under the UPA administration owing to retrospective changes in the law that allowed tax officials to go after deals that had been closed years earlier. "If such a patently unintended interpretation is adopted, which should obviously not be the case, foreign investment would be needlessly and adversely impacted at a time when the need is to rebuild credibility," Dalal said.

Currently, taxes on short-term capital gains from equity and equity-linked products is 15%. Long-term capital gains are not taxed.

FPIs investing in India through Mauritius that claim tax benefits under the tax treaty with the island nation do not pay any taxes on gains from the stock market. On the other hand, MAT is levied at about 20% on book profit.

"If FPIs have to pay MAT, it would mean that the concessional tax regime of 0%/15% would have no relevance and all capital gains income (whether short term or long term) would be subject to a 20% tax rate," said Rajesh H Gandhi, partner, tax, Deloitte Haskins & Sells. The purpose of providing long-term capital gains tax exemption for market trades would be defeated by such a levy, said Bijal Ajinkya, partner, Khaitan & Co. "Tax officials have randomly selected the FPIs to whom the notices have been sent," said a person who represents some of the investors.

"In some cases, these (FPIs) are non-corporate ones." The revenue department is pushing the income tax department to include the FPIs under MAT, said a person aware of the development. With the assessment years under scrutiny for MAT starting from 2012, the revenue department has to take a call on the matter by March 31 as this is time-barred. It's expected therefore that the MAT levy will be imposed on the FPIs by March 15 unless the Central Board of Direct Taxes (CBDT) tells them otherwise.

Whether MAT applies to foreign companies has been a matter of dispute in court. It's levied in situations where taxable profit is below a prescribed threshold in relation to book profit and was introduced after it was found that companies were paying dividends but no tax due to various exemptions. If an FPI doesn't claim benefits under a tax treaty, then it is subjected to Indian tax laws and is liable to pay MAT, goes the argument.

Tax consultants said if the tax department imposes the levy on FPIs, it would have a deleterious impact on net asset value (NAV) calculations.

"FPIs are not required to prepare a P/L (profit and loss statement) and balance sheet in India, and MAT provisions should not apply to them," said Dalal. "Clearly, that was not the intention, as indicated by the explanatory notes issued by the government when MAT provisions were issued." The levy was introduced around 17 years ago. Tax experts said the history of MAT provisions, as well as official communications issued when the law was introduced, suggest it was meant to apply to domestic companies and not foreign ones.

The issue of whether MAT applies to foreign companies has also been dealt with by the Authority for Advance Rulings in the Timken and Praxair cases, they said. It had been held that MAT is not applicable to foreign companies that do not have a permanent establishment in India, they said.

Besides, large institutional investors that invest in diverse jurisdictions would find it administratively cumbersome to calculate MAT as prescribed under the tax law. Such moves may lead to these investors shying away from investing in Indian capital markets.

"Imposition of MAT on FPIs would make India an unattractive investment jurisdiction," said Khaitan's Ajinkya. "This is the result of some enthusiastic tax officers sending notices. I think that the government should intervene at some point," said a senior tax adviser at one of the big four consulting companies.

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