Why Finance Minister Arun Jaitley is Pranab Mukherjee 2.0 for the markets

The Finance Minister has failed to assuage markets’ fears on the issue of retrospective tax

Markets are getting jittery each time the finance minister or his ministry utters the T word. Finance Minister Arun Jaitley reminds the market of UPA’s finance minister Pranab Mukherjee, who introduced the now-dreaded retrospective tax. Despite repeated mentions and explanations by Jaitley and Prime Minister Narendra Modi, the markets are not convinced that this government is sincere about not taxing foreign firms on a retrospective basis.

India is not a tax haven and taxes that were payable by foreign investors should be paid and others should be challenged, Jaitley said earlier this month. Markets did not take kindly to these words, correcting sharply despite a global rally.

Just when the market was stabilising on Tuesday, finance ministry officials were quoted as saying that the government will not relent to pressure from FIIs for withdrawing taxes worth Rs 40,000 crore that is is due from earlier years.

Clearly, the government is in a fighting mood. Unfortunately, neither the finance minister nor his ministry seems to grasp the repercussion of such a move on the markets. Broking firms are already jittery on the government stance and have organised conference calls between tax experts and their clients. The general perception is that taxes on FIIs pertaining to prior years will hurt sentiments.

The fear is that FIIs might be asked to pay taxes on capital gains from 2009 onwards. Foreign funds would have already either redistributed those profits or re-invested them. The markets fear that the only way they can pay tax is by selling Indian shares.

Confrontation between the government and FIIs depends on an ongoing case in Supreme Court where Castleton Investments, a Mauritius based company has challenged the ruling of Authority of Advance Rulings (AAR) in India. Government officials are largely going by the precedent of the case of Castleton Investments, wherein the Authority for Advance Ruling (AAR) gave a verdict in August 2012, that Castleton is liable to pay MAT when it transferred shares from a Mauritius entity to a Singapore entity. Castleton Investments is owned by the Wellcome Limited of UK that held shares of Glaxo India which it transferred to its Singapore entity as part of the post-merger restructuring of Glaxo and Burroughs Wellcome.

Broking firms feel that the move by tax authority will dampen spirits. CLSA has come out with a note titled Tax Menace, saying that if the Supreme Court upholds the AAR ruling then the case of the income tax authorities will become very strong. CLSA organised a Q&A with tax experts from Deloitte who said that investment entities incorporated as ‘companies’ will only be impacted. Other structures such as trusts and partnerships should be safe.

The taxpayers could potentially go to the Disputes Resolution Panel (DRP) against these orders, says the note. DRP gives its verdict in nine months and tax liability, if any, will materialise only then. The option of going to the Supreme Court, ultimately, always exists. This means that the uncertainty would be long drawn and will be an overhang on the market.

Edelweiss interacted with Anish Thacker, Partner, Ernst & Young (E&Y) and concluded that the probability of levying MAT on capital gains by FIIs is very low and even lower for tax payers registered in countries where the double taxation avoidance agreement (DTAA) provides tax benefits. Thacker said that there is a consensus view within the tax consulting community that MAT should not be applicable on foreign companies, including FIIs and FPIs. Since these entities are not required to prepare books of accounts in India, levy of MAT on book profits does not arise.

There are several cases where decisions have been in favour of the tax payer and MAT has not been levied as in the case of Timken, Praxair Pacific and Krung Thai Bank. However, Edelweiss notes that the Castleton Investment case outcome will be applicable.

Finance Minister Arun Jaitley did his bit in making life uncomfortable for the FIIs. In the recent budget he made it clear that ‘going forward’ MAT will not apply to foreign companies. This has been interpreted by tax authorities as MAT will be applicable for past years. Thankfully the statute of limitations in India is seven years implying that tax authorities cannot issue notices to cases prior to 2008-09.

Tax experts feel that it will take three years for Supreme Court to announce its judgment in the Castleton Investments case, till such time markets will be jittery.

In any case FIIs have a case to be annoyed by Indian laws. First they are invited to invest in the country by the government promising them no taxation if they enter through countries with which India has signed tax treaties and then they are issued tax notices on grounds of technicalities and change of rules. The spirit of the law has not been followed.

These are not confidence building measures by the Indian government. Jaitley has clearly failed in allaying fears of FIIs and every time he and his ministry demands tax from FIIs market feels nothing has changed with a change in government. Jaitley is nothing but Pranab 2.0.