Indian Government Provides Business Friendly Clarification for MAT

By Dezan Shira & Associates

Editor: Tracie Frost

The Government of India recently affirmed that Foreign Institutional Investors (FII) and Foreign Portfolio Investors (FPI) are not liable for minimum alternative tax (MAT ) in India if they have no permanent establishment or place of business in India.

The clarification, which came in Instruction 9/2015 on September 2, is a welcome announcement to foreign investors, especially those who have been issued notices seeking payment of MAT for periods prior to April 1, 2015.

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Making Sense of the Minimum Alternative Tax

The MAT is a local tax that India has levied on companies since 1987 and applies when a company’s income tax is less than 18.5 percent. Historically, the tax has not applied to foreign investors. FIIs and FPIs generally earn income from investments in securities and operate largely from foreign destinations with no a place of business in India. Income earned by these companies is generally not taxable in India in the absence of a physical presence.

However, in 2010 Castleton Investment Ltd., a Mauritius-based foreign company with no permanent establishment in India, sought an advance ruling for confirmation that it was not liable for MAT on a transaction it was contemplating. Disregarding precedent, the Authority for Advance Ruling (AAR) determined that even foreign companies are subject to MAT.

Since the 2012 AAR ruling, several major foreign investors have been issued notices for payment of MAT. The uncertainty surrounding application of MAT caused the financial services industry to press the issue with the Indian government. As a result, Finance Minister Arun Jaitley introduced an amendment to the 2015 budget which excluded foreign companies from MAT effective April 1, 2015.

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The amendment had the unfortunate, but perhaps unsurprising, effect of causing Indian tax authorities to conclude that prior to April 1, 2015, foreign companies were liable for the MAT. As a result, following the amendment, the Central Board of Direct Taxes issued 68 notices to foreign institutional investors demanding over 6 billion rupees in retroactive MAT assessments. Foreign institutional investors responded by pulling $2.5 billion out of Indian stocks in one month alone.

Following the industry outcry, in May, Finance Minister Arun Jaitley formed a panel to study and clarify the issue. The September instruction contains the panel’s conclusions and recommendations. The panel concluded that there is no basis for assessment of MAT tax on FIIs/FPIs and advised that the Income Tax Act be amended “so as to prescribe that MAT provisions will not be applicable to FIIs/FPIs not having a place of business/permanent establishment in India, for the period prior to April 1, 2015.”

The instruction further directed CBDT tax authorities to “keep in abeyance…the pending assessment proceedings in cases of FIIs/FPIs involving [MAT, and] not pursue the recovery of outstanding demands”. The government accepted the panel’s recommendations, and new rules are expected to be drafted shortly.

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A Major Change

The changes signal the government’s desire to improve India’s image as an investment destination. Significantly, the panel noted, “FIIs are mostly open-ended investment funds, which permit their investors to enter and exit daily, based on the NAV of the fund, unanticipated tax liability (or the fear thereof) relating to previous years, which would have to be borne by the current investors, may be a sufficient trigger for the investors to exit”. 

The MAT dispute epitomizes the difficulties of reforming India’s fraught tax code. There is often conflict among the tax authorities, the country’s courts, and the legislatures, with tax authorities sometimes refusing to comply with court decisions. In this case, the quasi-judicial AAR issued an opinion in direct contradiction of precedent, and the tax authorities opted to follow this decision rather than several decisions ruling that FIIs/FPIs are not liable for MAT.

When the Government sought to clarify the rules using the legislative process, the result was a loophole that gave tax authorities even greater impetus to assess the tax. Fortunately the panel’s recommendations – and the Government’s acceptance – seems to put the matter to rest.

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