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The History of MAT & FPI Taxation

Published on Mon, Apr 27,2015 | 20:27, Updated at Mon, Apr 27 at 20:29Source : 


 By: Ameet Patel, Partner, Manohar Chowdhry & Associates     


Statutory warning: This article is a long one.



Anyone who follows stock markets in India would, by now, be aware of the burning controversy surrounding levy of Minimum Alternate Tax (MAT) on a few Foreign Institutional Investors (FIIs) (now known as FPIs or Foreign Portfolio Investors). Most financial newspapers and TV channels have been carrying reports and views of experts on this issue. Several statements have been attributed to the Union Finance Minister Mr Arun Jaitley, the Minister of State for Finance Mr Jayant Sinha and also to the Revenue Secretary Mr. Shaktikanta Das and the CBDT Chairperson Ms. Anita Kapur. The stock market indices have lost hundreds of points in the past few days. India has once again come back to centre stage on the international front for her unpredictable tax policies.

To begin with, what is MAT?
MAT was first introduced into the Income-tax Act, 1961 (ITA) in 1987. An entirely new Chapter XIIB was introduced into the ITA vide Finance Act, 1987. The Memorandum to the Bill explained the rationale for bringing in these provisions as under (emphasis supplied):

“New Provisions to levy minimum tax on “Book Profits” of certain companies

37. Under the existing provisions of the Income-tax Act, certain deductions are allowed in the computation of profits and gains of business or profession. Various deductions are also allowed under Chapter VI-A of the Income-tax Act in computing total income. As a result of these concessions, certain companies making huge profits, are managing their affairs in such a way as to avoid payment of income-tax.

With a view to making the tax system more progressive, a new Chapter XIIB is proposed to be inserted in the Income-tax Act.”


In the Finance Act, 1990, MAT was abolished. However, it was reintroduced in Finance Bill, 1996 with effect from Assessment Year 1997-98. The wording of the then newly introduced section 115JA were similar to the original wording of section 115J. Even at that time, in the Explanatory Memorandum, reference to the impact of the MAT in terms of tax rate was clearly with respect to domestic companies and not foreign companies.

In the interim, we have various case laws (which are referred to later in the article).

Fast forward to 2015. Section 115JB of the current ITA contains the working of the amount on which MAT is to be paid. The relevant portion of the section is reproduced below (emphasis supplied).

“(2) [Every assessee,—

(a)  being a company, other than a company referred to in clause (b), shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Part II of Schedule VI to the Companies Act, 1956 (1 of 1956); or

(b)  being a company, to which the proviso to sub-section (2) of section 211 of the Companies Act, 1956 (1 of 1956) is applicable, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of the Act governing such company:]


Further, the Explanation to section 115JB reads as under (emphasis supplied):

Explanation [1].—For the purposes of this section, "book profit" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by—


Essentially, what the MAT provisions say is that a company needs to pay MAT if the normal tax payable by it is less than the MAT and that the MAT is to be computed with reference to its Book Profit as per Profit and Loss Account.

Thus, when the MAT provisions were introduced, the intention of the Legislature was clearly to tax certain companies who were otherwise profitable but who were not paying income-tax on account of various deductions. What is however, more important to note is that at the time of introducing the MAT provisions, the then government had Indian companies on its radar. This is obvious from the Memorandum to the Finance Bill 1987. In the Memorandum, there is a clear reference to deductions from profits and gains of business or profession and also to Chapter VIA deductions. The computation mechanism laid down for MAT also envisages a “net profit as per profit and loss account”. It is a no brainer that for a company to have a profit and loss account, it is necessary to have books of account.

Now, with the above background, let us see what the present controversy is.

In the Finance Bill, 2015, the current Finance Minister Mr Jaitley has proposed certain relaxations for FIIs / FPIs on the MAT front. The relevant portion of the Minister’s speech is reproduced below:

116. In order to rationalise the MAT provisions for FIIs, profits corresponding to their income from capital gains on transactions in securities which are liable to tax at a lower rate, shall not be subject to MAT


Why was this amendment necessary? Prior to the Budget of 2015, there had been a few press reports where references were made to the levy of MAT on FIIs. At that point of time, it was not a major controversy. Only a handful of FII may have got notices from the tax department asking them to pay MAT on their profits or asking them to show cause why MAT should not be levied on their profits. Such an action on the part of a few ingenious tax officers was creating an uncertainty. Before the matter ballooned into a full blown controversy, several representations had been made to the Finance Minister to clarify in the Budget that MAT was not applicable to FIIs. It was in response to such representations that the amendment was proposed in the Budget. Thus, the said amendment was meant to be and is a clarificatory amendment. Unfortunately, the amendment that has actually been proposed in section 115JB is slated to be effective F.Y. 2015-16 (relevant to Assessment Year 2016-17).

Issues arising on account of the amendment proposed in the Finance Bill 2015:

The representations that were made to the Finance Minister prior to the budget were all asking for a clarification to the effect that MAT was not applicable to FPIs. On the other hand, now, the tax department has every right to say that MAT is applicable to FPIs. It is only the capital gains (on which STT is paid) that is to be excluded from the “book profit” on which MAT is to be calculated.

Further, this also means that interest income earned by FIIs which presently attracts a low withholding tax rate of 5% as also capital gains on which STT is not chargeable will come under the purview of MAT and would therefore attract a higher overall tax. This implies that while the withholding from interest income would be at a rate of 5%, the FII would need to pay advance tax for the balance portion of the MAT rate. This clearly makes the section 194LD meaningless.

Therefore, now, after the amendment, FIIs are in a worse off position than they were before. Earlier, it was only in a few cases that the concerned officers had raked up the issue of MAT. Now, in all cases, the officers will legitimately apply MAT (subject to provisions of DTAA dealth with in later paragraphs).

Secondly, even though the amendment is clarificatory in nature, it has been made effective A.Y. 2016-17. This would result in an interpretation that for all prior years, MAT was payable even on capital gains. This is a double whammy for FIIs.


Therefore, after the Budget of 2015, what was earlier only a small problem has suddenly become a massive one. Every day, we are reading reports of tax demands being raised on FIIs. Initially, the reports spoke of demands to the tune of INR 40,000 crores (approx. $ 6.35 billion). Thereafter, we have got reports that quote the Minister of State Mr Jayant Sinha saying that demand notices have been sent in 68 cases for INR 602 crores (approx. $ 95 million) towards MAT. Despite the wide variance in the two figures and despite the belief that the figure of Rs. 40,000 crores is an absurd figure (see a later para on this issue), it is clear that the tip of the iceberg is itself large and therefore, the hidden iceberg would be of an alarming size. It is not clear from the press reports as to for which year these demands have been raised. Presuming that the demands are for Assessment Year 2012-13 (because that is the year for which tax assessments have closed recently), then one can get a fair idea of the size of the total demands that could get raised if more FPIs are roped in and if all the subsequent years (Assessment Years 2013-14 to 2015-16) are opened up and the FPIs are made to pay MAT on the capital gains and interest income!

What is very disturbing for foreign investors (as also the tax professionals in India) is the attitude of the tax officials and the ministers. Initially, even the Finance Minister stoutly defended the demands. Some of the statements that have been reported in the press after the controversy became a raging one are as under:

On 6th April, Mr Jaitley said: “Even when legitimate taxes are demanded when courts have settled issues, amendments have been made for the future; if people are aggrieved, they have the right to challenge it. But having lost in courts, you cannot refer to the process as tax terrorism.” He also said that “while India doesn’t endorse tax terrorism, it is not a tax haven either, and that taxes which are payable must be paid, and this shouldn’t be seen as tax terrorism.”

On 6th April, the Revenue Secretary Mr. Shaktikanta Das  said: “The law will naturally apply for the prior period. The amendment proposed will take place from 1 April 2015. So prospectively, there will be no MAT on the FPIs, but the prior period demand is confirmed by the advance ruling authority, so naturally it will stand.”

Another statement attributed to a Revenue official as reported in the press recently:

“While reiterating the government’s commitment to a non-adversarial tax regime, the Centre claimed the MAT for foreign portfolio investors is a legacy issue, currently sub-judice and therefore can’t be dealt with retrospectively. The CBDT chairperson told the FIIs that assessing officers have been instructed to “pass orders very quickly” in cases where notices have been sent. “As per the existing law, it was necessary to send the notices. However, when they are taken up, they may get quashed,” the official said.”

On what basis have the demands been raised?

Primarily, the Finance Minister has publicly stated that the tax demands are based on a favourable ruling of the Authority for Advance Ruling (AAR). For this, he has placed reliance on the decision of the AAR in the case of Castleton Investments and ZD both of which were decided upon in the year 2012. Unfortunately, the Revenue authorities seem to have cleverly kept away from the Finance Minster the fact that in three other decisions of the AAR, it has been held that the foreign companies are not liable to pay income tax unless they have a permanent establishment in India (Timken, Fidelity and Royal Bank of Canada). Further, in the case of Fidelity, it was also specifically held that an FII, appointing a custodian in compliance with SEBI Regulations, did not attract MAT. The Finance Minister also seems to have conveniently overlooked the fact that the decision of an AAR is binding only in the particular case and should not serve as a precedent.

Admittedly, there are about eight judgements - of AAR and the Income-tax Appellate Tribunal on this issue. In all these decisions, it has been consistently argued and accepted that if a foreign company had a place of business in India, then that company was liable to MAT and if it did not have a place of business in India, then it was not liable to MAT.

FIIs and Place of Business in India

This brings us to the question as to whether an FII/FPI has a place of business in India at all. It is an admitted and well known fact that none of the FIIs maintain books of account in India as they are not required to do so. They are also not considered as having a place of business in India. Every FII / FPI has to appoint a custodian / DDP in India. Even these custodians / DDPs are not considered to give rise to a place of business in India as far as their FII / FPI customers are concerned. In fact, in the Budget 2015, there has been a further amendment that proposes that subject to certain conditions, the presence of a fund manager in India will not constitute a PE in India for offshore funds. The Indian Companies Act does not apply to foreign companies. So, the Schedule VI of the said Act also does not apply to such companies.

The combined reading of the proposed amendment as well as the established and accepted proposition that an FII does not have a place of business in India suggests to everyone except the tax authorities that MAT cannot apply to foreign companies and FIIs. It was never the intention of the legislature to apply MAT to FIIs. And, the reader would definitely recollect that time and again, the finance ministers of India (especially those belonging to the previous regime) have always relied on the “intention” of the legislature to bring out retrospective amendments to counter favourable decisions of courts obtained by various tax payers after years of litigation. In the current context, the same “intention” is conveniently forgotten! Instead, we hear a statement to the effect that “we do not like to make any retrospective amendments; just as Vodafone was a negative retrospective amendment we do not want a positive retrospective amendment. Therefore for the past years, let the law take its own course.”

It may not be out of place to mention that FIIs have been around for more than 2 decades now. If the intention of the legislature was that FIIs are to be subjected to MAT, then why was this not done for so many years? Can we, as a country, allow a set of investors to believe (by way of our conduct) that they are not covered by MAT, assess them accordingly for 2 decades, attract huge amounts into the country by way of investments and then, one fine day, suddenly change our mind and start taxing them under MAT? What kind of a signal are we sending to the foreigners? Have we not done enough damage to our reputation through the Vodafone imbroglio?

What happens to the FIIs that hail from countries with which India has a DTAA?

If press reports are to be believed, it appears that notices of tax demands have been issued to companies which have offices in India but whose parents are located in countries not covered by tax treaties. However, companies which do not have offices or any physical presence here, even if they operate from countries not covered under a tax treaty, have not received such tax demands. It may be noted that India has DTAAs with 88 countries. Out of these, 85 treaties re in force. The DTAAs with Mauritius, Singapore, Cyprus, France and the Netherlands exempt funds from capital gains tax in India. On the other hand, the DTAAs with the US, UK and Luxembourg empower India to impose capital gains tax as per her domestic law. Statistically, the top four countries from which FIIs have invested into India are USA, Singapore, Mauritius and Luxembourg all of whom, as mentioned above, have DTAAs with India.

On 23rd April, with a view to calm frayed nerves of FIIs, the Finance Ministry did some firefighting. In a call with several FIIs, where the Finance Minister, the Revenue Secretary and the CBDT chairperson were present, the following statement was issued: “This means that FIIs from Singapore and Mauritius will not have to pay the tax as these countries have DTAA with India, while they have zero capital gains tax. We will also clarify if minimum alternate tax (MAT) would be levied prospectively from April 1 on other incomes like interest on bond, private equity and foreign direct investment. This clarification can be expected soon,”

Miscellaneous Issue of Return of Income

A small but significant matter has not been talked about in the various discussions that have been taking place on the issue of MAT for FIIs. In the tax return forms applicable for companies (ITR-6), there is an entire section where the company tax payer has to fill in details of its entire Balance Sheet and Profit & Loss Account. This is not a new section. It has been in place for many years now. Over the years, most FIIs, while filing their tax returns in ITR, have been keeping this section blank. This fact is known to the tax department. In many cases, the Central Processing Centre which electronically accepts and processes tax returns has, in the past, sent out notices to several FIIs that the returns filed by them were defective because the Balance Sheet and Profit & Loss Account details have not been filled in. In response, most FIIs have replied that because they are foreign companies, they are not required to maintain books of account as per the Indian Companies Act in respect of their investment related activities in India and therefore they have not filled up the said section in the ITR-6. These replies of FIIs appear to have been accepted by the CPC because thereafter, no further action has been taken by it in the matter. In most cases, the Intimations under section 143(1) too have been received from the CPC. This is a clear indication that they have accepted the contention of the FIIs that they are not expected to maintain books of account as per Indian Companies Act. This is an important point. It has a direct nexus with the issue of levy of MAT. If books of account are not required to be maintained, how can one have a Profit & Loss Account and therefore, how can one even begin to compute MAT?

Rs. 40,000 crores of demand – is this realistic?

One wonders who was the first reporter who mentioned this figure and from where he/she got it. It was interesting for me to receive the following note on a social media site:

40,000 crores as MAT tax (at 20%) would translate to a profit of 200,000 crores. Even if one presumes that FIIs made a profit @ 100% of their investment, it would mean that FIIs sold stocks worth 400,000 crores or almost $60+ billion. Have we seen such a sell off in any year? If we have such a huge liquidation, the Indian stock markets would crash substantially. In fact, there would be chaos in our financial system.

Therefore, one must ponder on where the figure first surfaced and how! In any case, subsequent clarifications from the Ministry have cleared the air and the amount stands corrected to Rs. 602 crores.

What would happen to the stock markets in the meantime?

On the one hand, some would like to believe that FIIs would flee from India if the MAT controversy is not settled very soon in favour of the investors. Others however feel, and rightly so, that the FIIs invest in a particular country not because of tax considerations but purely for profits. If the post tax returns are attractive, then they would invest in a country. Thus, as far as India is concerned, even if the MAT finally stays and FIIs are subject to the same, they may not necessarily panic and run away if they expect to get good returns even after paying the MAT. There is considerable merit in this second school of thought. However, the real problem is that if FIIs are not sure of the tax impact then its not good news for them. First of all, if past assessments are reopened now and demands are raised on the FIIs, it will create all kinds of problems for the FIIs. Firstly, many of the investors in the FIIs may have already exited and taken their money out. In such a case, from whom would the FII recover the tax? Secondly, the NAVs of the FIIs would get seriously eroded when the tax demands are factored in. These NAVs would be current NAVs and would therefore affect the current investors of the FIIs. This would give rise to fresh problems between the FIIs and their current investors. However, one thing is certain. If MAT is levied on the interest income of FIIs then there would surely be an exodus from the Indian debt market. A 20% tax on interest income leaves very little in the hands of the investor. If the FIIs start exiting the debt market, there would be serious consequences for India. The ambitious plans that the government has of building 100 smart cities and of the push towards better infrastructure both would get adversely impacted. The Finance Minister should keep this in mind while taking a final call in the matter.

In the meantime, investors and tax professionals are all grappling on the MAT and waiting for the taxing time to pass. It is however clear that to those for whom MAT MATters will do well to keep their calculations ready so that if the government does not relent, they are at least aware of the downside that they face!


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