The Implications of India’s Minimum Alternate Tax (MAT) for Foreign Investors

By Dezan Shira & Associates
Editor: Nishant Dixit

The general optimism over India’s foreign investment climate under the business-friendly leadership of Narendra Modi is starting to fade away as the country institutes major tax demands on foreign investors.

In April, over 100 Foreign Portfolio Investors (FPI) were served tax notices requiring them to pay the Minimum Alternative Tax (MAT) which traditionally has not been applied to foreign funds.

The controversy over MAT is ongoing as it has already appeared in three major cases: Vodafone (US$2.5 billion tax bill), Nokia (US$340 million), and Cairn Energy (US$1.6 billion). The most recent MAT related tax demands could be as high as US$8 billion.

MAT: An Obscure Tax from the Onset

The Minimum Alternate Tax was introduced in Indian tax law in 1987, well before India’s 1991 economic reforms and the beginning of foreign portfolio investment in its capital markets in 1993.  The tax was first meant to expand the tax net to companies that distributed dividends to their shareholders but did not pay taxes due to various tax incentives.

The provision saw two more iterations with its reintroduction in 1996 and revision in 2000. The notes to the 2002 finance bill that amended the provision state that MAT would apply only to domestic companies. However, the regulation itself, which is section 115JB of the Indian Income Tax Act, does not clarify whether the company referred to in the law is foreign or domestic.

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Costs to Foreign Portfolio Investors

MAT applies when tax payable on a company’s taxable income is less than 18.5 percent of their book profit. The company will have to pay 20 percent tax of book profit if their taxable income is less than 18.5 percent. If MAT is applied to FPIs, they will have to pay about 20 percent tax on their long-term capital gains and 5 percent on short term capital gains made before April 2015.

The most recent tax demands are based on a ruling from the Authority of Advance Rulings in October 2012 in which it held that MAT was applicable to foreign funds that had no permanent establishment in India.

Out of the 8000 Foreign Portfolio investors, so far only about 100 have received notices regarding their MAT obligations. Approximately 6000 FPIs in total could eventually face a MAT tax demand. This could potentially spell trouble for the prospect of foreign investment into India. Large institutional investors invested nearly US$40 billion in Indian equities and debt in 2014 alone, and any loss of investment would cause major problems for the Indian economy.

In his 2015 budget speech, Finance Minister Arun Jaitley reassured FPIs that their income from capital gains on transactions in securities which are liable to a lower tax rate would not be subject to MAT starting on April 1, 2015. The controversy is over whether this exemption applies to transactions made before the specified date.

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Implications for FPIs

The disputes over MAT are becoming a legal battle. On April 7 2015, The Financial Express quoted India’s revenue secretary as saying that, “The government has… made it clear that legal recourse is open to the FPIs.”

As India is putting its taxation system in order and trying to close existing loopholes, both sides – the government and private investors – are expected to use ambiguous language of regulations like MAT to their advantage.

Thus, Foreign Portfolio Investors have to make sure that their tax accounting and regulatory filings are current and accurate. They should revisit the calculation of book profits as relating to MAT as well as recheck Authority for Advanced Rulings orders obtained at the time of structuring the fund into India.

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