The foreign portfolio investors (FPIs) structured as companies recently received communications from the tax department asking them to pay minimum alternate tax (MAT) on their gains in Indian markets. The notices, sent in May and June, were with respect to the assessment years 2008, 2009 and 2010.

A source familiar with the development said the issue came up during internal review of orders and the tax department took the view that such foreign investors were also subject to MAT. The foreign investors involved are already said to have sent their replies to the notice and the tax department is now set to take the final call.

The tax department did not respond to a request for comment. But a source said: “In cases of rectification, old orders are seldom upheld. Such cases typically go against the taxpayer.”

MAT was originally introduced as a way to deal with companies that had very large profits but did not pay much in the way of taxes due to various tax adjustments and incentives. Tax experts say the provisions seem geared for Indian companies but the tax authorities have previously attempted to apply these to foreign companies as well. An appeal against the move is pending in the Supreme Court.

Now, applying the same provisions to FPIs structured as companies will mean an effective tax rate of around 20 per cent on long-term capital gains, as opposed to zero earlier.

Bijal Ajinkya, partner, Khaitan & Co, says the move might make the Indian capital market less attractive for FPIs. “India is one of the few countries that levy a capital-gains tax on non-residents. Tax on short-term capital gains on capital market exits is charged at 15 per cent, while long-term capital gains are exempt from taxation. This streamlined rate of taxation has led to the vibrancy of the Indian capital market, with many international players accessing it. Charging MAT on such trades might affect the buoyancy of the market and send out a negative signal to foreign investors,” she says.

Pallavi Bakhru, director, Grant Thornton Advisory, says judgments in such cases have shown a mixed trend.

“The Authority for Advance Rulings’ views have been both in favour of and against taxpayers. The issue is pending before the Supreme Court for a final resolution. Depending on the court’s verdict, FPIs will need to realign their tax positions... A MAT levy on capital gains will reduce India’s attractiveness as an investment destination,” Bakhru said.

Foreign portfolio investors, like other investors in India, pay zero tax on long-term capital gains. This will change to a minimum tax of 18.5 per cent, plus surcharge, taking the tax rate to 20.01 per cent. This move is to apply to all foreign investors structured as companies. And, experts say, that is a large chunk of all FPIs in India.

Suresh Swamy, executive director (financial services), PricewaterhouseCoopers, says it is debatable whether MAT can be extended to foreign companies. The provisions require that the accounts of a target company are in line with the standard policies decided in its annual general meeting. “Companies (including corporate foreign institutional investors/FPIs) incorporated outside India with no place of business in India are neither required to prepare their accounts nor hold AGMs in India. Besides, the starting point for computation of book profit is profit according to their profit-and-loss accounts. The new government had recently made amendments to the Income-Tax Act to clarify FIIs only earned ‘capital gains’ and not ‘profits and gains from business’.”

The government had in 2012 introduced the general anti-avoidance rules (GAAR), a provision that gives tax authorities the power to deny tax benefits to entities setting up subsidiaries in treaty jurisdictions like Mauritius only to avoid taxes. This was to be applicable from 2012. But, after the move received some negative feedback, it has not yet come into effect.

FIIs (now called FPIs) have been net-buyers to the tune of Rs 84,988.54 crore in the Indian equity market so far this calendar year.